Can a high-yield ASX dividend stock still be safe?

Not every high dividend yield is at risk of being cut.

| More on:
A man in a blue collared shirt sits at his desk doing a single fist pump as he watches the Appen share price rise on his laptop

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Key points

  • Some businesses on the ASX offer very high yields
  • But, a few of them could be yield traps – the next 12 months may not be as good as the last 12 months
  • I think that companies with resilient earnings and a high dividend payout could be contenders

There is a broad range of ASX dividend shares for investors to consider. The question is: Are those high-yield ASX dividends a mirage? Can the payments continue?

Firstly, it's important to remember that dividends are not guaranteed. Companies may reduce or completely cut their dividend payments.

Let's first consider how large dividend yields can occur.

What makes a high dividend yield?

Three main factors could lead to a big yield, in my opinion.

First, a low price/earnings (p/e) ratio can lead to a higher dividend yield.

For example, imagine a business makes $100 million in profit and has a market capitalisation of $1 billion. The p/e ratio is 10 – the market cap is 10x the earnings. If it paid out $50 million as a dividend, that's a dividend yield of 5% with a dividend payout ratio of 50%. If franking credits were involved and the dividend was fully franked, the grossed-up dividend yield would be 7.1%.

Secondly, the business could have a high dividend payout ratio.

Now, let's say a business makes $100 million in profit, but has a market cap of $1.5 billion. In this case, the p/e ratio is 15. This business is priced noticeably higher than the first example. But, if it paid out $80 million of its net profit, the dividend payout ratio would be 80%, and the dividend yield 5.3%. It's a 7.6% grossed-up dividend yield, including franking credits.

The third factor is that last year's dividend could be a lot bigger than what the market is expecting this year's dividend to be.

This could be because the company paid a one-off special dividend last year or business profitability has significantly reduced since then. Or perhaps the business just wants to hold onto its cash.

Are high-yield ASX dividend shares safe?

I think it depends on each business.

There are plenty of examples of special dividends that are unlikely to be repeated again and again. For example, a business may have sold off a division and sent the sale proceeds to shareholders. It can't sell the same business segment again.

A business that is going through pain may cut its dividend. For example, Magellan Financial Group Ltd (ASX: MFG) paid a total dividend of $1.79 per share in FY22, a trailing 19.5% dividend yield. But, Commsec numbers suggest Magellan could pay an annual dividend per share of 87 cents per share in FY23 and 68 cents per share in FY24, which is a yield of 9.5% and 7.4%, respectively.

Resource companies and retailers often have quite a low p/e ratio.

But, resource companies such as miners heavily depend on what happens with the commodity price. They will probably see both boom times and weaker times, so I wouldn't call them 'safe', but they can be rewarding.

Retails can also see cyclical earnings as households go through cycles, so the dividend may go up and down as well.

Businesses with low p/e ratios may not necessarily offer safe dividends. If business earnings are not consistent or defensive, then the dividend may well be volatile as well.

Companies with high dividend payout ratios may well be able to pay consistent dividends if their actual earnings are also consistent. Businesses that operate in defensive sectors, such as APA Group (ASX: APA), Sonic Healthcare Ltd (ASX: SHL), Metcash Limited (ASX: MTS) and Propel Funeral Partners Ltd (ASX: PFP) may be able to keep paying resilient dividends.

Foolish takeaway

So, high dividend yields may or may not be safer than lower yields – it depends on the company, the industry they come from and how resilient the underlying earnings are.

I wouldn't count on resource companies paying reliable dividends year after year, but some businesses with a high dividend payout ratio could be candidates to consider.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Apa Group. The Motley Fool Australia has recommended Metcash, Propel Funeral Partners, and Sonic Healthcare. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Dividend Investing

Smiling woman holding Australian dollar notes in each hand, symbolising dividends.
Dividend Investing

2 ASX passive income shares paying 8% and 13% yields

I think both these high yielding ASX dividend stocks offer long-term passive income potential.

Read more »

A woman in hammock with headphones on enjoying life which symbolises passive income.
Dividend Investing

After passive income? Check out these ASX 200 dividend shares

ASX dividend shares can provide a reliable source of passive income

Read more »

Australian notes and coins symbolising dividends.
Materials Shares

BHP is paying $2.30 per share in dividends. Time to buy the stock?

Do analysts think the Big Australian is a buy?

Read more »

A couple sits in their lounge room with a large piggy bank on the coffee table. They smile while the male partner feeds some money into the slot while the female partner looks on with an iPad style device in her hands as though they are budgeting.
Dividend Investing

3 ASX dividend shares named as buys for income investors

Analysts think income investors should be snapping up these stocks.

Read more »

ATM with Australian hundred dollar notes hanging out.
Dividend Investing

Buy these ASX stocks for 6% to 8% dividend yields

Big dividend yields are expected from these shares according to analysts.

Read more »

Accountant woman counting an Australian money and using calculator for calculating dividend yield.
Bank Shares

How much do you need to invest in NAB shares for $12,000 in annual dividends?

Enjoying $12,000 in annual dividend income is no easy feat...

Read more »

Hand holding Australian dollar (AUD) bills, symbolising ex dividend day. Passive income.
Dividend Investing

Here's the Rio Tinto dividend forecast through to 2028

Has the miner's dividend peaked or will it continue to grow?

Read more »

an older couple look happy as they sit at a laptop computer in their home.
Dividend Investing

Buy these ASX dividend shares for passive income

Analysts think these shares could be top options for income investors.

Read more »