Have you ever heard of what investors call the “value trap”. A value trap happens when a stock is trading at a very appealing P/E ratio. Investors think they have found the deal of the year and they buy it without thinking further. The problem is that sometimes, the stock is a value trap: it’s worth a lot today, but the economics around the stock will eventually lead the company to be less profitable. This is why the P/E ratio will never go higher. Investors are then stuck with shares trading at a low P/E ratio but they will never catch up and go back to a higher multiplier. This is the value trap. Now, there are also dividend traps!
Dividend Investing is definitely one of the most popular and successful ways of investing. But it doesn’t mean that it works all the time. The whole point of dividend investing is obviously to get paid regardless what is happening in the markets. Some investors are so used to receiving their dividend distributions that they forgot they don’t own certificates of deposit and they are not receiving interest. Dividends are not 100% secured. In fact, dividend investing can also bring you big losses. There are some pitfalls you must avoid during your dividend investing journey:
#1 The High Dividend Yield TrapIf you have been following this blog for a while, you should have learned that the dividend yield should not be a factor in your investment process. Actually, as long as the dividend yield meets a minimum requirement (mine is set at 3%), you should not prefer a stock because it pays better than another one.
The high dividend yield trap is caused by greed. Investors are nostalgic from the time when we used to have Canadian Oil Income Trusts paying 8-9% with steady monthly distribution (anybody still hold ERF?). If you are still looking for high dividend paying stocks, you are heading towards the high dividend yield trap. This means that you buy the stock for its distribution. Unfortunately, there is a small print at the bottom of your trading slip: it says that the stock is unlikely going to continue paying its high dividend!
In the current market, there is one reason why a stock would pay higher than 5% in dividend; it’s because the dividend payout is not sustainable. If the market doesn’t think that the company will continue to pay its dividend, it starts selling the stock. The price goes down and the dividend yield goes up by default. If the dividend yield has increased significantly over the past 12 months and it’s not because the company is increasing its dividend, you are in a high yield dividend trap. Here are a few stocks that may represent a trap:
|Ticker||Name||Price||Dividend Yield||Payout Ratio|
|AGF/B||AGF Management Ltd||11,9||9,08||88,59|
|FRU||Freehold Royalties Ltd||19,42||8,65||182,72|
|MKP||MCAN Mortgage Corp||13,15||8,09||103,68|
|PWT||Penn West Petroleum Ltd||13,68||7,89||79,31|
|BA||Bell Aliant Inc||24,95||7,62||132,35|
|BNP||Bonavista Energy Corp||18,23||7,9||145,81|
|FN||First National Financial Corp||16,85||7,42||164,75|
|AFN||AG Growth International Inc||33||7,27||122,78|
|PBN||PetroBakken Energy Ltd||12,45||7,71||85,88|
|FC||Firm Capital Mortgage Investment Corp||13,26||7,06||100|
|Ticker||Name||Price||Dividend Yield||Payout Ratio|
|FSC||Fifth Street Finance Corp||10,11||11,37||271,27|
|HRZN||Horizon Technology Finance Corp||16,38||10,99||81,69|
|CNSL||Consolidated Communications Holdings Inc||15,86||9,77||175,49|
|TCRD||THL Credit Inc||13,8||9,28||170,46|
|ARCC||Ares Capital Corp||16,63||8,9||90,46|
|NTLS||NTELOS Holdings Corp||21,2||7,92||204,45|
|BNPUF||Bonavista Energy Corp||18,6379||7,85||145,81|
|PWE||Penn West Petroleum Ltd||13,61||7,74||79,31|
|NYB||New York Community Bancorp Inc||12,98||7,71||91,02|
|BLIAF||Bell Aliant Inc||24,957||7,61||132,35|
#2 The Being Paid To Wait TrapWe often hear about the good side of dividends during bear market as you are being paid to wait. We all know it’s not the right time to sell when the market is down. While your stock might take a 15% slump, you still earn your juicy dividend of 3-4%. This reduces your paper loss and encourages you to keep your stocks longer. But is the distribution enough to keep you waiting five years?
Pfizer (PFE) is a good example. Over the past 5 years, the stock has generated a big 1.66% investment return (dividend excluded) and over 10 years; we are at -17.91% (as at July 31st). Is the 3.64% dividend distribution enough to wait that long? It’s even worse in the case of PFE since they cut their dividend back in 2009 during the financial crisis.
Closer to my portfolio, my recent experience with ZWB proves that the dividend yield is not enough to keep you waiting. After a year, I lost money on this trade while making a juicy 8% dividend yield. However, when I combined my dividend payout with the portfolio value, I was still at a loss. I sold ZWB and bought STX (Seagate Technology) instead. This is how I made by my money back in just three weeks. Will I continue to ride STX now that their latest results missed analysts estimate for the first time in 5 quarters? That is a pretty good question!
Because we buy dividend stocks for dividend growth.
Because we buy dividend stocks with a long term view.
Because we get paid quarterly for our patience.
Dividend investing also causes procrastination! We comfort ourselves as investors by thinking that we are not day traders and that we should buy solid companies paying steady dividends. This is why so many investors want to keep their investments for life. But the problem is that they keep the wrong stocks in their portfolio for too long.
Receiving a check every three months should never be a reason to keep a stock. Don’t become a lazy investor because you are watching your dividend yield more than you look at your portfolio value. You might be holding the wrong stocks that are vegetating around 1% growth while other companies are growing faster and still pay dividends. In order to not fall in the “being paid to wait trap” I suggest you reassess the reason why you bought your stocks on a yearly basis. If the reasons are not there anymore, there is only two options left; get stuck in the trap or sell!
Here’s a few examples of stocks with no returns over the past 5 years.
|Ticker||Name||Price||Dividend Yield||5 year return|
|MFC||Manulife Financial Corp||10,77||4,83||-67,2|
|AGF/B||AGF Management Ltd||11,9||9,08||-56,38|
|AAH||Aastra Technologies Ltd||17,02||4,7||-48,68|
|SLF||Sun Life Financial Inc||21,78||6,61||-43,69|
|ET||Evertz Technologies Ltd||12,98||4,4||-39,26|
|RET||Reitmans Canada Ltd||12,23||6,54||-35,65|
|IAG||Industrial Alliance Insurance & Financial Services Inc||22,35||4,38||-33,79|
|GS||Gluskin Sheff + Associates Inc||14,45||4,5||-30,29|
|PWT||Penn West Petroleum Ltd||13,68||7,89||-29,51|
|Ticker||Name||Price||Dividend Yield||Total Return 5 years|
|AI||Arlington Asset Investment Corp||22,36||15,65||-70,67|
|PBI||Pitney Bowes Inc||13,36||11,22||-61,05|
|NAT||Nordic American Tankers Ltd||11,7||10,26||-54,14|
|RRD||RR Donnelley & Sons Co||12,12||8,58||-61,72|
|LXK||Lexmark International Inc||17,49||6,86||-55,92|
|SLF||Sun Life Financial Inc||21,68||6,45||-39,97|
|AVP||Avon Products Inc||15,49||5,94||-53,4|
|GCI||Gannett Co Inc||14,11||5,67||-63,76|
|STRA||Strayer Education Inc||72,66||5,51||-46,33|
|VALU||Value Line Inc||11,86||5,04||-63,74|
|MFC||Manulife Financial Corp||10,72||4,86||-64,97|
|STFC||State Auto Financial Corp||12,97||4,63||-41,14|
|AM||American Greetings Corp||13,29||4,51||-38,48|
|ANAT||American National Insurance Co||70,43||4,37||-42,04|
|HVB||Hudson Valley Holding Corp||16,86||4,28||-46,04|
|BANC||First Pactrust Bancorp Inc||11,25||4,27||-36,82|
|CMTL||Comtech Telecommunications Corp||27,32||4,03||-33,49|
#3 The High COP Dividend TrapThis third trap was brought up in a comment from Richard on “When Do You Sell When You Make Money?”. He mentioned that he keeps a few stocks paying very high dividends based on their cost of purchase (COP). If you do a good job with your stock selection, you will eventually get stocks paying 8% to 15% dividend yield based on your cost of purchase. In fact, the most courageous of you who bought Canadian Banks back in December 2008 are probably earning 25% dividend yield on theirCOP! This, unfortunately, is quite an exception.
More realistically, if you buy a company like Coca-Cola (KO) which historically doubles its dividend payout every 6.5 years, you will be earning a 7-8% yield in ten years. Then the catch is similar to the one found in the “being paid to wait” trap. Would you take your steady 8% dividend yield from a company that might only go down or would you restart with a fresh company paying a *small* 3% dividend yield but which is very promising? For the record, I’m not saying that KO should be sold because it’s going nowhere; I’m just taking the company as a good example.
In fact, when you look at the dividend aristocrats you have great examples of stocks that are continuously increasing their dividend payouts but don’t necessarily provide capital gains to investors. Here’s a quick list of underperforming aristocrat stocks over the past five years that are providing high COP dividend yield:
Cincinnati Financial Corp (CINF)
Pitney Bowes (PBI)
Sysco Corp (SYY)
Nucor Corp (NUE)
I totally understand that 8% yield is quite attractive. It’s actually the whole point of becoming a dividend investor; to seek dividend growth. You might have made a brilliant choice a few years ago, but it might not be the case today. Sometimes, you are better off selling your stock at profit than cashing your 8% dividend yield without real return.
Or you can also look at stocks that have a 3% dividend yield and a high 5 years dividend growth. I think that those 2 metrics combined could show some interesting picks:
|Ticker||Name||Price||Dividend Yield||Dividend Growth 5 years|
|CEU||Canadian Energy Services & Technology Corp||10,53||5,7||11,66|
|GRT||Granite Real Estate Inc||35,8||5,59||19,26|
|BDT||Bird Construction Inc||13,73||5,24||10,11|
|CTY||Calian Technologies Ltd||20,67||5,03||21,44|
|SJR/B||Shaw Communications Inc||19,57||4,96||16,37|
|CBY||Canada Bread Co Ltd||43,25||4,62||35,59|
|GS||Gluskin Sheff + Associates Inc||14,45||4,5||35,89|
|KMP||Killam Properties Inc||13,05||4,44||19,97|
|CSU||Constellation Software Inc/Canada||92,49||4,43||62,72|
|CJR/B||Corus Entertainment Inc||22,69||4,23||13,34|
|CFW||Calfrac Well Services Ltd||23,7||4,22||43,1|
|SJR/A||Shaw Communications Inc||23,89||4,05||16,44|
|RCI/B||Rogers Communications Inc||39,31||4,02||48,89|
|CMG||Computer Modelling Group Ltd||18,48||3,46||34,23|
|LNF||Leon's Furniture Ltd||11,95||3,36||15,3|
|NMC||Newmont Canada FN Holdings ULC||46,55||3,07||23,83|
|TPX/A||Molson Coors Canada Inc||42||3,07||12,33|
|Ticker||Name||Price||Dividend Yield||Dividend Growth 5 years|
|PNNT||PennantPark Investment Corp||10,44||10,73||51,3|
|TCAP||Triangle Capital Corp||22,93||8,72||65,81|
|NTLS||NTELOS Holdings Corp||21,2||7,92||43,41|
|FFBC||First Financial Bancorp||15,96||7,52||12,24|
|TAL||TAL International Group Inc||34,15||7,03||34,12|
|CFNB||California First National Bancorp||16,24||6,77||19,05|
|OB||OneBeacon Insurance Group Ltd||12,69||6,62||14,87|
|CLF||Cliffs Natural Resources Inc||40,89||6,11||42,42|
|STRA||Strayer Education Inc||72,66||5,51||27,49|
|CALM||Cal-Maine Foods Inc||37,73||5,51||75,61|
|GRP||Granite Real Estate Inc||35,58||5,47||21,47|
|SJR||Shaw Communications Inc||19,52||4,97||19,04|
|LEG||Leggett & Platt Inc||23,18||4,83||10,17|
|ELRC||Electro Rent Corp||16,76||4,78||51,57|
|SAFT||Safety Insurance Group Inc||42,38||4,72||14,87|
|GHL||Greenhill & Co Inc||39,72||4,53||15,39|
|AM||American Greetings Corp||13,29||4,51||10,76|
|LMT||Lockheed Martin Corp||89,27||4,48||22,67|
|STX||Seagate Technology PLC||30,02||4,26||17,75|
|UNS||UNS Energy Corp||40,7||4,23||14,34|
|TWGP||Tower Group Inc||18,64||4,02||49,63|