Listed investment company (LIC) WAM Capital Limited (ASX: WAM) has just announced a 7.75 cents per share final dividend. That brings the total dividend paid to WAM Capital shareholders over the past 12 months to 15.5 cents per share.
At today’s share price (at the time of writing) of $1.89, WAM Capital is now offering a trailing dividend yield of 8.2%. WAM Capital’s dividend typically comes fully franked as well (as is the case with this payout). Including these franking credits, WAM Capital’s grossed-up dividend comes in at a staggering 11.71%.
How does WAM Capital invest?
As a LIC, WAM Capital invests in a diversified portfolio of ASX shares. Originally, WAM Capital concentrated more on the small-cap side of the ASX investing world. but since this LIC has over $1.14 billion in assets under management, it now dabbles in the mid- and large-cap space as well. WAM Capital’s modus operandi is finding growing ASX companies with what the company describes as a ‘catalyst’ for further share price appreciation. This might be the identification of market undervaluation of a particular ASX share, an expected earnings beat, or an industry growth trend.
WAM Capital buys these undervalued companies and then sells them when the catalyst has been realised. This strategy has worked pretty well for WAM Capital. Since its inception in 1999, the LIC has returned an average of 15.6% per annum to its investors (before fees and taxes). Over just the past year, WAM Capital has lost 2.8% compared with the broader market’s 7.2% loss, meaning the company has delivered outperformance of 4.4%.
Is WAM Capital a buy for ASX dividend income today?
A stupendous grossed-up dividend of 11.71% might make this company look like a no-brainer buy right now. But perhaps things aren’t as rosy as they seem for WAM Capital. An LIC is only able to fund dividend payments through its profit reserve. If the reserve is full, the dividends can flow freely. But if the reserve is empty, no such bounty is possible.
As of 31 May, WAM Capital had 6.1 cents per share left in the profit reserve after funding this 7.75 cents per share payout. Now, even if mathematics isn’t your strong suit, you can probably see the problem here. WAM Capital is going to have to pull more than one rabbit out of its hat if it is to keep its current payout levels going forward.
The company even hinted at this upcoming flashpoint in its dividend announcement today, stating:
In FY2021, the Company’s ability to continue paying fully-franked dividends is dependent on generating additional profit reserves and franking credits. the ability to generate franking credits is reliant on the receipt of franked dividends from investments and the payment of tax on profits.
In other words, ‘we’re in trouble here’.
In my view, WAM Capital’s generous dividend is masking the possibility this company may be a dividend trap right now. As such, I would stay away from WAM Capital today — especially as the company is trading at a premium to its underlying assets anyway. There are better deals out there for dividend investors, in my opinion.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Bapcor. The Motley Fool Australia owns shares of A2 Milk. The Motley Fool Australia has recommended Elders Limited. 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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