We all love a high-yielding ASX dividend share. But looking for dividends at the top of the yield range is a dangerous game.
Often, the markets place a company’s dividend at a high point for a reason. You’d better make sure you know what you’re doing when you buy these kinds of shares otherwise, you might end up being caught in the dreaded dividend trap.
So today, let’s talk about four things to look for when searching for high-yielding ASX dividend shares
4 things to watch when searching for your next high-yield ASX dividend share
Is the ASX dividend share in good shape?
The ASX is full of dividend shares that are at their core healthy businesses. But businesses can run into trouble for all sorts of reasons, and the market can adjust their share prices accordingly. This is certainly something to watch out for from a dividend perspective.
If a company pays out a certain dividend one year but then runs into trouble, then it will probably not be able to afford that same level of dividend payouts the next year.
But as the market moves to include these woes in a company’s share price, it can push up its trailing dividend yield to what looks like an attractive level. This has happened over the past couple of years with Magellan Financial Group Ltd (ASX: MFG).
Magellan paid out an interim dividend of $1.10 per share in 2022. But a collapse in the fund manager’s funds under management (FUM) dramatically kneecapped the company’s ability to keep those payouts going. This year, Magellan’s interim dividend was just 46.9 cents per share.
Mining and energy shares
Some of the ASX’s largest displayed dividend yields come from the mining and energy sectors. Take BHP Group Ltd (ASX: BHP). Its shares presently sport a dividend yield of over 8.5%. Woodside Energy Group Ltd (ASX: WDS) has an even higher trailing yield on the table, around 9.9% right now.
These might look attractive, but the ability of these companies to fund dividends rides almost entirely on factors outside their control – mainly the commodity prices of the iron ore, oil, and gas they can sell. This means that mining and energy shares’ dividends are highly cyclical, and should never be taken for granted.
To illustrate, BHP paid an interim dividend worth $1.31 per share in 2021, $2.08 per share in 2022, and back down to $1.36 in 2023.
Payout ratios
The payout ratio is one of the best metrics a dividend investor can use when assessing a high dividend yield. It tells us the proportion of a company’s earnings per share (EPS) that the company is doling out as dividends.
If a company’s payout ratio is at 40%, it means there is a lot of room to grow payouts in the future, provided its earnings are stable or rising.
But if a dividend stock has a payout ratio of 98%, there’s a reasonable chance there is a dividend cut coming investors’ way.
As an example, let’s look at Coles Group Ltd (ASX: COL). In the 2022 financial year, Coles made 78.8 cents in earnings per share and paid out 63 of those cents as dividends to investors. That gives Coles a payout ratio of 80%.
Considering Coles’ maturity and scale, that’s a payout ratio I would consider appropriate for strong dividends going forward.
So checking out a high-yielding ASX dividend share’s payout ratio should be one of the first things you do when checking out a high-yielding share.
Diversification
In the search for high-yielding shares, many investors forget the basic premise of diversification. Most of the ASX’s highest-yielding shares come from similar sectors. I would wager that the average retiree’s dividend portfolio would include at least two of the big four banks, BHP, Woodside, and maybe Telstra Group Ltd (ASX: TLS) or Woolworths Group Ltd (ASX: WOW).
Gravitating towards the most generous dividend payers for an income portfolio is fine. But you don’t want to wake up one day and find that half of your portfolio is in ASX bank shares, for example.
It would mean that if the Australian banking sector faced a specific issue and the ASX banks had to cut their dividends simultaneously, you would be in hot water fast.
Diversification is still an important consideration when building a dividend-focused portfolio,
