Is WAM Capital Limited (ASX:WAM) a buy for its 10% dividend yield?

The WAM Capital Limited (ASX: WAM) grossed-up dividend yield is now 10%, is it a buy?

Indeed, with the share price falling to $2.18 so far today it’s actually offering a trailing yield of 10.15% right now.

There are few shares on the ASX that offer that kind of yield and even fewer where that yield is sustainable.

WAM Capital is one of the largest and longer-running listed investment companies (LICs) on the ASX. It’s been going since 1999 and had nearly $1.4 billion of gross assets at the end October 2018.

Its job is to invest in small and medium ASX businesses that it thinks are undervalued growth shares where a catalyst can improve the valuation.

Some shares like Telstra Corporation Ltd (ASX: TLS) have been a yield trap. WAM Capital has backed up its dividend by growing its portfolio by an average of 16.2% per annum before fees and expenses over the past decade. This has allowed WAM Capital to increase its dividend every year since the GFC, the dividend has been sustainably increased.

There’s no doubt that if the dividend can continue to grow sustainably, even at 3% a year, today’s yield looks very attractive.

However, returns have been lower in recent times due to the maturing of this long-running bull market. Over the past three years its portfolio has returned 11% per annum before fees and expenses, which is still a market-beating performance.

The two reasons that have stopped me investing in WAM Capital in recent times have been its premium to NTA and its profit reserve.

WAM Capital has been trading at a premium of at least 20% to its underlying assets in recent times. It’s currently trading at a 13.5% premium to the NTA reported at the end of October 2018, however that NTA doesn’t include the just-paid dividend of 7.75 cents per share, so the premium may well be near 20% or more again.

WAM Capital has a smaller profit reserve compared to some of its WAM peers like WAM Research Limited (ASX: WAX) and WAM Microcap Limited (ASX: WMI). A profit reserve is important for smoothing out dividend payments.

Foolish takeaway

WAM Capital is a high-quality LIC. If its dividend can continue to be sustainably increased then it would be a great income share today with a 10% yield. But, the yield may almost be too high if the market keeps falling and WAM Capital has to use up its profit reserves. I’m not personally a buyer of WAM Capital yet.

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Motley Fool contributor Tristan Harrison owns shares of WAM MICRO FPO. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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