The National Australia Bank Ltd. (ASX: NAB) share price has been steadily recovering from its December lows of around $22.80 and is currently trading around $25.16. This current price represents a P/E ratio of 11.03, which is looking quite low, especially compared to its 'Big Four' stable mate Commonwealth Bank of Australia (ASX: CBA), which is currently hovering around a P/E of 14.16.
NAB's current dividend payout is $0.99 per share, which means NAB is yielding over 11% grossed-up. This dividend is huge and represents one of the largest yields amongst the top 50 ASX stocks (if not the entire ASX). But is this yield secure or is NAB going to be the next big dividend trap?
What does a classic yield trap look like?
If you are an income investor, you will have probably had an extremely negative experience with the shares of Telstra Corporation Ltd (ASX: TLS). Telstra cut its cherished dividend substantially in April 2017, from $0.31 per share to $0.22 (a cut of almost 30%), which prompted an instant free-fall in its share price.
If you had bought Telstra shares in March 2017 for income, you would have been the victim of this classic dividend trap – where a dividend yield is too good to be true and gets cut down the road. Dividend trap scenarios usually result in a substantial loss of capital, as the market can often be expected to re-price these stocks heavily to maintain the yield going forward.
Is NAB a dividend trap?
NAB's payout ratio is currently 85%, which means that the company is only keeping 15% of its profits for internal investment.
This ratio is relatively high and indicates that NAB has very little room to grow its dividend substantially in the short-term. In my opinion, it also means that if NAB's profits are disrupted (say by a housing slump), then it is very likely NAB will have to cut its dividend to make up the difference, as this already-high payout ratio doesn't provide much of a buffer.
Foolish takeaway
On current prices, buying NAB shares for the high yield alone is a risky choice, in my opinion, considering NAB's vulnerability to any external economic shocks. Saying this, even if NAB cuts their current dividend yield, it would still likely be a good income stock going forward, albeit with potential capital loss from the share price.
