Buy Hold Sell: 3 dividend traps (and 2 you can trust)

Everyone loves a bargain. It's why Boxing Day sales are such a riot, or why my car salesman father tries to haggle nearly everything he buys. But as in life, sometimes a deal (or yield in this case) is too good to be true. 

Dividend traps occur when investors (like you, my dear reader), are lured in by a high dividend yield before realising the underlying company isn't all it is cracked up to be. Particularly now with inflation running so hot, it's easy to see why alluringly high yields would catch an investor's eye. 

However, if a company's share price continues to plummet, or it turns out the company can't pay the dividend it promised - that seductive dividend yield will turn into a trap.

In this episode, Livewire's Ally Selby is joined by Wheelhouse Partners' Alastair MacLeod and Plato Investment Management's Dr Don Hamson for their analysis of three stocks with sky-high yields that could just be dividend traps. 

And for a little bit of positivity, we also asked our fundies to each name one stock with a dividend yield you can actually trust. 

Now, that's what I call value for money. 

Note: This episode was filmed on Wednesday 26th October 2022. You can watch the video, listen to the podcast, or read an edited transcript below.

Edited Transcript 

Ally Selby: Hey, how are you doing? And welcome to Livewire's Buy Hold Sell. I'm Ally Selby, and today we have an absolute cracker of an episode for you. We're going to be discussing three stocks that may just be dividend traps and two that you can actually trust. To do that, we're joined by Alastair MacLeod from Wheelhouse Partners and Dr Don Hamson from Plato Investment Management. 

Okay, first up, no surprise here, it's Magellan Financial Group. It has a gross trailing yield of around 24%. Starting with you, Al, is that a buy, hold, or sell?

Magellan Financial Group (ASX: MFG)

Alastair MacLeod (SELL): It's a sell. The inner contrarian in me wants to think there's an opportunity with this stock because it's fallen so much. I mean, they've lost 50% of FUM. But when you're trying to get a base case for what's the worst-case scenario, there aren't any assets here other than the brand. There's still outflow. To get a sense of that base level of earnings is very difficult to gauge. They really need to generate some outperformance in their flagship strategy. And as any professional manager knows, trying to get outperformance at any time, but particularly when you need it, is difficult enough. So I'd like to think that there's an opportunity there, but you just don't know what that base level of earnings is and therefore yield. So you just don't need to be there. It's a sell.

Ally Selby: FUM's fallen, but its share price has also fallen too. It's down around 48% since the beginning of the year. Is it worth the risk for that trailing yield, Don? Is it a buy, hold, or sell?

Don Hamson (SELL): No, it's not worth the risk in our view. It's a sell. We've been calling it a dividend trap all year because we know the fund's management business, we're a fund manager, and if your FUM’s going out the door very quickly, it's very hard to turn that around. Performance is hard to get, and they have a particular style, and it's not a great outlook for the moment for the growth style. So as long as interest rates keep going up, I think it's going to be tough for growth managers full stop. And I think it's going to be tough for them to turn that around. I'm sure they will eventually, but I think it's too early to call it at the moment.

Alumina (ASX: AWC)

Ally Selby: Okay. Next up we have Alumina. It has a gross trailing yield of around 14%. Don, is it a buy, hold, or sell?

Don Hamson (SELL): It's a sell for us. We think it is a dividend trap being squeezed by higher costs. Obviously, we have inflation around the world, and alumina prices aren't going in the right direction, like a lot of other commodities. So they're getting it from both sides. So for us, it's a dividend trap, and you don't have to be there. We don’t own it.

Ally Selby: Okay, its share price has dropped around 31% in 2022. Al, over to you. Is it a buy, hold, or sell?

Alastair MacLeod (SELL): I think for an income investor, it's a sell. I think there's a good chance that the next dividend doesn't come through. It's really getting squeezed by, as Don said, Spanish gas and alumina prices. They're in the wrong spot. So I think from an income perspective, it's a sell. However, from a total return perspective - unlike Magellan, it's got assets. Think of the replacement cost for a lot of these assets. It's trading at a significant discount. Through the cycle, from a sort of deep value perspective and total return, I think there may be an opportunity there. But look, in the short term, from an income perspective, it's a sell.

Tabcorp (ASX: TAH)

Ally Selby: Okay, next up, we have Tabcorp. It has a trailing yield of around 14%, but obviously, earlier this year it announced the demerger of its lottery business. Is that a buy, hold, or sell?

Alastair MacLeod (SELL): It's a sell. Typically, when there's a spin-off (when a business spins off an asset), you want to look at where senior management go to understand where the quality business is. Now the CEO retired or resigned, but the CFO and the Chief Risk Officer both went to The Lottery Corporation. It's a bigger business, but it's also a much higher-quality business. So you look at the Tabcorp business, the runt, they've got a retail channel that they've got to reinvest in. Sports betting is growing, which is at the cost of horse racing, which is not their natural business. The dividend yield is about 3% and pretty much flat because they've got all this other reinvestment going on. So for us, it's a sell.

Ally Selby: Okay. Its share price has fallen around 2% in the red since the beginning of the year. Don, is it a buy, hold, or sell?

Don Hamson (BUY): It's a buy for us, actually. We quite like it. We think it's good value, and they're cycling some comparisons to a COVID-19 period when things were much tougher. So they actually have recently announced some better results. So we like it. It's a buy for us.

Ally Selby: So not a dividend trap for you?

Don Hamson: Not for us, no.

Woodside Energy Group (ASX: WDS)

Ally Selby: Okay. I'm excited about this. We asked our fundies to bring along one long-term sustainable dividend payer for the year ahead. Dom, what have you brought for us today?

Don Hamson (BUY): Well, we like the energy stocks, and we like that outlook. And longer term, we think Woodside's a great stock. It's got some quality assets. I know it's in fossil fuels, but gas and LNG are on the pathway to lower emissions. It'll help us get there. Obviously, it is benefiting from the Ukrainian crisis, but we think it's got a great dividend outlook for a number of years.

The Lottery Corporation (ASX: TLC)

Ally Selby: Al, can you beat that? What's your sustainable dividend payer today and why?

Alastair MacLeod (BUY): We talked about Tabcorp before, and I'll point to the spin-off, The Lottery Corporation. It's actually a stock that hasn't paid a dividend yet and is not likely to in the next six months because a lot of the profits are still going back to Tabcorp. But looking forward, this is a regulated monopoly. It's expected to have around a 4% yield. If you think about the lottery business, most people know when you're buying a lottery ticket, it's a bit of a mug's game. So the same logic goes, selling lottery tickets is a great business. If you look at the cash flows of this company, depreciation's higher than CapEx. So cash flows are bigger than earnings. So from an income investor's perspective, your cash flows can be 130% of what your profits are. I think there's a lot of runway for this stock from a dividend growth perspective in a very economically defensive environment or position.

Ally Selby: Is a 4% yield attractive when inflation's running so hot?

Alastair MacLeod: Well, it's a 4% yield that's also growing at 10%. And then you've got the capital base growing as well. So yes, I think it's a good place to be, even in an inflationary environment.

Ally Selby: Okay. Well, that's all we have time for today. I hope you enjoyed the episode as much as I did. If you did, why not give it a like? Remember to subscribe to our YouTube channel. We have so much great content coming every single week.

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