15% dividends? Don’t be fooled

It’s hard to believe but some companies may actually pay dividends as high as 15% – at least some might be fooled into thinking so.

Dividends are predetermined and calculated based on share price movements. When a company declares a dividend in its annual report, it forecasts future earnings against cash flow and long term objectives. When searching for stocks in any market, you must be sure not to fall into a ‘value trap’.

When something is too good to be true — like high dividends and low P/E ratios — it generally is. The way these stocks build up their low P/Es and high dividends is by analysts calculating the figures off the past 12 months of earnings and declared dividends, otherwise known as a current P/E. It is a backwards looking tool that may use information from when the company was doing really well, but now has hit a rough patch, so don’t trust it for anything more than an indication of past performance.

Mining services stocks have taken a beating in 2013 and some of the “current” dividend yields may look good, but wait for the next annual report because they may remove a dividend altogether. Ausdrill (ASX: ASL), Macmahon Holdings (ASX: MAH) and Sedgman (ASX: SDM) boast dividends of 10.4%, 12.9% and 15.3% respectively, all fully franked. Numbers don’t lie but in this case they’re not telling the truth about the stock — these three have each fallen approximately 60% in the past year alone.

Foolish takeaway

Don’t trust everything you read; companies that compile information for stock brokers and ratings agencies get it wrong – frequently. Remember, even though companies like UGL (ASX: UGL) and Monadelphous Group (ASX: MND) pay hearty dividends and have low P/Es, the only true ‘value’ can be realised when a buyer agrees to pay up in the open market.

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Motley Fool contributor Owen Raszkiewicz does not have any financial interest in the companies mentioned here.

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