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Why a High Dividend Yield Can Be Dangerous

Dividends can be a great reason to invest in a share. After all, having another source of income – one which might even grow over time if the investment’s made wisely – would be welcomed by most.

That being said, investors who blindly invest in high-yielding dividend shares might be taking on more risks than they know – just because a share has a high-yield now is no guarantee that it can continue delivering that yield.

Remembering a sunken shipping trust

First Ship Lease Trust (SGX: D8DU) is a business trust that owns a portfolio of vessels which it leases out to shipping companies on a bareboat charter basis most of the time. In the beginning of 2010, the trust was trading at around S$0.60 per unit and actually carried a dividend yield of about 7.1%. That was an extremely generous yield in the low interest rate environment in Singapore. Yet, those who invested in the trust back then would have seen the value of their investment sink by more than 80%. To add salt to those wounds, the trust has also made a complete halt to their dividends along the way.

Knowing how to avoid the sea mines

An investor might have avoided these losses if he/she had asked the basic but very important question of, “Is the yield sustainable?” A quick analysis of First Ship Lease’s business would have turned up some red flags; the trust had a poor business model and bad credit control.

High yield gems… or traps

Today, it is not exactly hard to find high-yielding shares in the market. For instance, we have China Merchants Holdings (Pacific) Ltd  (SGX: C22), Lippo Malls Indonesia Retail Trust (SGX: D5IU), and Asian Pay Television Trust (SGX: S7OU). These shares (and trusts) are yielding 8.6%, 7.3%, and 9.0% respectively at their current prices.

But, are their yields sustainable? If you are confident in the business prospects of these shares, then their yields might indeed be sustainable and they could be real gems for your portfolio. But if you have doubts, then look to First Ship Lease Trust for a taste of what might happen if their yields turn out to not be sustainable.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.