When an ASX share has what looks like a dividend yield of 18% on the table, it is more than enough to compel at least a few investors to take a closer look. That's exactly what is happening with the Magellan Financial Group Ltd (ASX: MFG) sales price right now.
Yes, Magellan shares today have a trailing dividend yield of 18% on the table. Compare that with some other ASX dividend peers, and it looks even better. Commonwealth Bank of Australia (ASX: CBA), Telstra Group Ltd (ASX: TLS) and Rio Tinto Limited (ASX: RIO) are all famous dividend payers on the ASX. But CBA shares are offering a dividend yield of 'just' 3.57% right now. For Telstra it's 4.19%, and for Rio, 9.1%.
Magellan is running rings around its competition in this arena.
So this is a no-brainer buy, right? Buy some Magellan shares, get your capital back within six short years, and enjoy free dividend income from then until Judgement Day?
Well, not so fast.
Can Magellan shares really give investors an 18% dividend yield?
See, a dividend yield reflects the past, not the future. Magellan's whopping 18% yield is derived from the last two dividend payments the company has made. There was the March interim dividend of $1.10 per share, and the final dividend of 68.9 cents per share from September.
Together, that is a total of $1.79 in dividend income for 2022. This gives Magellan a trailing dividend yield of 18% on the current share price of $9.94 (at the time of writing).
But for investors to receive an 18% yield going forward, Magellan must keep its dividend payouts at or above these levels. And that is going to be very difficult for this company.
Many ASX shares have a codified 'dividend policy' – Magellan is one of those shares.
Here's what the company says its policy is when it comes to shareholder payouts:
The Company has a Policy of paying Interim and Final Dividends of 90% to 95% of the underlying net profit after tax of the Group's funds management business, excluding any performance fees.
In addition to the Interim and Final Dividends, the Company has a policy of paying an annual Performance Fee Dividend of 90% to 95% of the net crystallised performance fees after tax. Any Performance Fee Dividends will be paid annually alongside the Final Dividend.
So in order to have steady or rising dividends, Magellan must first secure steady or rising net profits after tax.
Falling profits mean falling dividends
Well, that's not what's happening. In its full-year earnings results for FY2022, Magellan reported a 3% drop in adjusted net profits after tax to $399.7 million. The company's profits before tax and performance fees fell by 11% to $470.6 million.
What's worse, Magellan averaged a funds under management (FUM) figure of $94.3 billion across FY2022. As of 31 October 2022, this figure had dropped to $51 billion with $2.4 billion in fund outflows over October alone.
A fund manager makes the lion's share of their profits from charging management fees on invested capital. Charging 1.35% on $94.3 billion of FUM is going to give you far more cash than 1.35% of $51 billion.
Thus, the likelihood of Magellan being able to even maintain its 2022 dividends next year, let alone grow them, is looking rather dire. If this is the case, investors won't be receiving anything close to an 18% yield on cost if they buy Magellan shares today.
But then again, we don't yet know what might happen. Magellan may be in some strife. But it is still a company with very little debt, and plenty of cash on its books.
Even if the company cuts its dividends by half next year, investors today would still enjoy a yield of around 9% on today's pricing.
So anything could happen. But when it comes to the 18% figure, don't be fooled. The fact that Magellan is trading on a trailing dividend yield of 18% right now is about as useful as a chocolate teapot.
