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Is this ASX banking share a dividend trap?

The ASX banking share I am referring to is no other than Westpac Banking Corp (ASX: WBC). The Westpac share price has had a stellar year so far, with WBC shares climbing from $24.48 in January to the $28.57 levels we’ve seen this week – a YTD gain of 17%. Westpac’s current pricing represents a price-to-earnings (P/E) ratio of 12.46, which is still looking cheap from the outside – Commonwealth Bank of Australia (ASX: CBA), by contrast has a P/E of 16.45.

Westpac’s current dividend is sitting at $1.88 per share (annualised), where it has remained since 2015. This gives Westpac a dividend yield of 6.57%, or 9.39% including franking credits – making it the biggest-yielding ASX bank at the moment.

But is this monster dividend too good to be true or will Westpac become a dividend trap?

What is a typical dividend trap?

Ask any AMP Limited (ASX: AMP) shareholder! A dividend trap occurs when investors buy a dividend-paying company for its ‘big’ dividend, only to find that the company cuts said dividend down the road. Even if you ‘Google’ AMP right now, you will see AMP as having a 7.69% dividend yield. But this is a trailing yield (i.e. based on its last dividend payment). AMP recently announced that its dividend would be suspended indefinitely going forward – so if you bought in a month ago looking for that 7% yield… sorry. A dividend cut is also often accompanied by a share price drop (have a look at AMP’s share price), so you can also be looking at a substantial capital loss – hence the name ‘trap’.

Is Westpac a dividend trap?

Westpac has a huge yield, but this comes at a cost – Westpac is currently paying out about 80% of its profits as dividends (based on 2018 figures). This leaves a very small buffer for other concerns – like compensation payments from the Royal Commission, for instance. In fact, Westpac is likely to have a much higher payout ratio this year because of these ongoing issues. So what happens if there is a property slump or economic shock? Well, there’s only one way for the dividend to go.

Foolish Takeaway

I think Westpac is a risky buy right now if you’re chasing dividends, particularly if you’re sensitive to a capital loss. Sure, the yield looks good at first glance, but so did AMP’s. In my opinion,  you can do a lot better at the moment.

Perhaps start with these blue chip dividend shares. 

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. 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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