Dividends are a great way for long-term investors to build their wealth. There’s no argument about that given the key role that dividends play in generating total returns.
Yet dividend stocks can also become traps, with unsuspecting investors lured into them by freakishly high dividend yields.
However, if a stock’s dividend yield is too high – over 6-7% – then usually there’s a reason why. Either the share price has fallen significantly or the stock market expects the company to cut its dividend.
Dividend cuts for companies that are known for paying dividends can result in a huge hit to the share price.
Here in Singapore, there are plenty of companies, including REITs and trusts, that have misleadingly high dividend yields.
One of the best examples of this “dividend trap” thesis is a former Straits Times Index constituent stock, Hutchison Port Holdings Trust (SGX: NS8U), also known as HPH Trust.
So what can dividend investors learn from the company’s demise over the past decade?
Yield isn’t everything
The Hong Kong-based port operator, which was actually spun out by tycoon Li Ka-Shing in 2011, trades for about US$0.23 a share now.
That’s a far cry from the US$1.01 that HPH Trust listed for a decade ago. So, if you had bought the shares in 2011 at the IPO price, you would have lost around 80% of your initial investment.
What was the reason for such poor performance? If anything, it highlighted the shift away from containers moving through Hong Kong towards the emerging ports of Shanghai and Shenzhen in China.
With trade tensions hitting cargo volumes, along with falling shipping rates for much of the past decade, it meant that HPH Trust’s business suffered.
Beyond the obvious fundamental reasons for HPH Trust’s dismal performance, the falling distribution per unit (DPU) – also known as the dividend – inevitably hurt its prospects.
Having listed in the first quarter of 2011, by the end of the year its share price was down to US$0.75 yet HPH Trust paid out a DPU of 37.7 Hong Kong cents (or 4.86 US cents).
Based on its 2011 ending share price of US$0.75, that equalled a really juicy dividend yield of 6.5%, if you ignore the fact that its shares lost a quarter of their value.
Falling dividends means falling share price
Fast-forward to today and HPH Trust’s most recent full-year 2020 saw a DPU of 12 Hong Kong cents. That means that HPH Trust’s dividend grew at a compound annual growth rate (CAGR) of negative 11.9%.
In various periods during the past decade, investors could have picked up HPH Trust shares that were yielding 9%, or even 10%, based on its 12-month trailing DPU.
Tellingly, by the time HPH Trust was kicked out of the Straits Times Index in late 2019, it was the worst-performing stock out of all 30 constituents.
But as investors, we need to remember to stay focused on dividend growth and ensuring that the DPU (or DPS) is expanding every single year for a sustained period of time.
That allows us to have visibility and, more importantly, confidence that what we are investing in can continue to pay us dividends over the long term.
The best way for dividend investors to measure performance is to look at the total return of a stock as this takes into account not only the dividend’s return but also the share price return.
Finding the sweet spot
For investors looking for solid dividend stocks that provide passive income, it’s ideal to look at yields that don’t indicate “danger” or flash a warning sign about the business.
Personally, I feel this ideal dividend yield range is between 4-6% but, as I always caveat, the growth of that dividend over time remains the most important defining factor for picking the best income stocks for the long term.
Disclaimer: ProsperUs Head of Content Tim Phillips doesn’t own shares of any companies mentioned.
