Here’s how WAM Research can afford to pay a 10% dividend yield

Here’s how WAM Research Ltd (ASX: WAX) can afford to pay a market-topping 10% dividend yield

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WAM Research Limited (ASX: WAX) is famous for the ability to pay large, fully-franked dividends to its shareholders.

Since 2010, this listed investment company (LIC) has delivered a return averaging 16.7% per year. A fair chunk of this return hails from dividend income – WAM Research has paid a rising dividend since 2008, of which its latest annual payout came in at 9.7 cents per share.

On its current share price, 9.7 cents per share translates into a yield of 6.62%, or 9.76% if you include the full level of franking. But here’s the kicker. WAM Research may trade for $1.42 a share today, but the actual value of its net tangible assets (NTA) per share is only at $1.24 today. This means that against their real value, WAX shares are paying out a dividend of 7.82%, or 11.17% grossed-up.

How can WAM Research afford this ridiculous dividend?

As an LIC, WAM Research invests in other ASX companies – it’s basically a company that acts as an investor. Specifically, the company plays in the small- and mid-cap space on the ASX, looking for companies that have upside catalysts or are otherwise mispriced by the market. Once this catalyst has expired and the company has appreciated in value, the LIC can sell out and bank the profit.

If all goes to plan, WAM Research passes these profits, along with the dividends it receives holding its stocks, to its shareholders as its own dividend. The company has clearly been very successful with this strategy, judging by its performance and the massive dividends it has continually supplied.

Is WAM Research a top buy for dividend income today?

You might be thinking ‘where’s the catch’ with this one, but there are couple of things to keep in mind if you’d like to ‘WAX on’ your portfolio.

Firstly (as mentioned above), WAX shares trade at a premium to their NTA – meaning you are essentially being asked to pay $1.42 for something that’s worth $1.24. Now many investors clearly think WAM Research’s past performance merits this kind of premium, but only you can decide for yourself if you are prepared to pay it.

Secondly, WAM Research’s more recent performance don’t impress me much (to borrow another phrase). This LIC has underperformed its S&P/ASX200 accumulation index benchmark over both the last year (by -6.9%) and the last 3 years (by -5.1%). I tend to have a long investing horizon myself, but if this continues it might start to be a cause for concern.

Foolish takeaway

Whilst I think WAM Research’s recent under-performance is concerning, I still think its a great stock to own for generous dividend income. I myself would wait for the premium to close up a bit (I don’t like overpaying for things), but many investors are still clearly happy to fork out for WAX shares, so it’s your call!

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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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