Avoid The Yield Trap

A high dividend isn’t always a good thing – it could even be a red flag

- John Mills

With continuing rock-bottom interest rates on savings accounts and term deposits, who wouldn’t want a good dividend? Yet buying a company just because it has a high dividend yield, and not undertaking further research, may not bring you the generous rewards you expect.

A company’s dividend yield is the dividend total it has paid over the previous 12 months divided by its share price, expressed as a percentage.

For example, Woolworths has paid 84 cents a share in fully franked dividends over the past 12 months. Using the share price of $27.70 at the time of writing, its dividend yield is 3% (84¢ divided by $27.70).

Our dividend imputation system modifies that figure. Imputation sensibly aims to remove the double taxation of dividends. That process leads to the term “grossed up” dividend yield, the dividend amount, in percentage terms, before personal taxation.

The figure enables individual investors to work out their own net yields. To calculate it, you just need to add any franking credits you received along with your dividends, then divide the new total by the company’s share price.

In the case of Woolworths, investors received 36¢ per share in franking credits over the past year, plus the 84¢ in dividends. The grossed-up dividend yield is therefore 4.3% (84¢ plus 36¢ divided by $27.70).

Notice that the dividend yield is calculated using the dividends a company has paid over the previous 12 months rather than what it will pay over the next 12 months. This leads to one of the issues with investing in a company just for a high dividend yield.