Are Fortescue shares a buy for income or are they a dividend trap?

Are Fortescue shares a 15.5% dividend trap right now?

| More on:
A man wearing glasses and a purple vest holds his hand to his chin and wonders

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

  • Fortescue shares seemingly have a dividend yield of 15.5% on the table today
  • A market expert explains how dividend traps work 
  • Fortescue shares are going for $19.17 each, up a healthy 1.11% so far this Tuesday

When one looks at the current Fortescue Metals Group Limited (ASX: FMG) share price, one metric might immediately jump out. That would be this iron ore miner's stupendous trailing dividend yield. Today, Fortescue shares are going for $19.17 each, up a healthy 1.11% so far this Tuesday.

At this share price, Fortescue's trailing dividend yield comes in at an eye-catching 15.5%. If we consider that this trailing dividend yield is also fully franked, we must also consider that this yield grosses up to an even more ludicrous 22.14% if we include the value of this franking.

So is this really what investors can expect if they purchase Fortescue shares today? Does this make Fortescue a buy today for dividend income, or is this just a big dividend trap honeypot?

A dividend trap refers to a situation where an ASX share has a seemingly attractive trailing dividend yield. But when an investor buys the shares expecting big income, they are disappointed when the company turns around and cuts its dividend, essentially 'trapping' the investor.

So is this the case with Fortescue today?

Well, let's see what one ASX expert reckons. Michael Maughan is head of the Tyndall Australian Share Income Fund. He recently shared his views on Fortescue with Livewire.

So Maughan acknowledges that "the miners have been the biggest part of the dividend pie over the last few years" on the ASX.

He notes that the current iron ore price is lower than it has been in 2022 today, but is still very high when compared to its long-term average pricing. As such, he stated that, "We expect the iron ore miners to be good cash flow generators and big payers going forward".

But does this mean Fortescue's mid-teens dividend yield is here to stay?

Are Fortescue shares a dividend trap today?

Well, not so fast, says Maughan. Here's how he described Fortescue's future dividend prospects:

There are two types of dividend traps. There's the cyclical aspect and there's the structural aspect. The cyclical aspect is you have companies that are going through cycles, the miners are a classic example. In times when the iron ore price is high, and in times when it's lower.

If you were to value that company on last year's earnings, when the iron ore price was US$220, that might not be the best benchmark to use upon which to value the company. And that came to bite. If you go back to a period like 2016 for the miners, that's a classic example of that.

…Fortescue falls into that same bucket with miners. Yes, I would definitely not use last year's yield as a way to value the company, because a yield in the high-teens is obviously too high. So if the market we're using that yield, then the stock would be much higher.

So investors definitely shouldn't count on Fortescue's trailing dividend yield as a reason to go out and buy more Fortescue shares today, according to Maughan.

But that doesn't mean Fortescue is a dud investment by any means. Chances are the miner will continue to pay out healthy dividends as long as the iron ore price remains historically elevated.

But a 15.5% yield going forward? That might be a bridge too far.

Motley Fool contributor Sebastian Bowen 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 no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Resources Shares

An engineer takes a break on a staircase and looks out over a huge open pit coal mine as the sun rises in the background.
Resources Shares

4 reasons to buy BHP shares today

A leading expert outlines four key reasons BHP shares are a buy.

Read more »

Businessman walks through exit door signalling resignation
Resources Shares

Pilbara Minerals share price drops as CFO announces resignation

It’s been a challenging few years for outgoing Pilbara Minerals CFO Luke Bortoli.

Read more »

Miner looking at a tablet.
Resources Shares

What happened with the BHP share price in May?

Did you buy BHP shares in May? Here’s how much the ASX 200 miner returned.

Read more »

Two men in hard hats and high visibility jackets look together at a laptop screen at a mine site.
Resources Shares

Should I buy Fortescue shares today?

A leading investing expert offers his verdict on the outlook for Fortescue shares.

Read more »

A female miner wearing a high vis vest and hard hard smiles and holds a clipboard while inspecting a mine site with a colleague.
Resources Shares

Is this a good time to buy BHP shares?

Should investors jump on the ASX mining shares right now?

Read more »

a miner holds his thumb up as he holds a device in his other hand.
Broker Notes

Why Macquarie expects this ASX 200 copper stock to surge 36% in a year

Macquarie forecasts some hefty gains ahead for the ASX 200 copper miner. But why?

Read more »

A young African mine worker is standing with a smile in front of a large haul dump truck wearing his personal protective wear.
Resources Shares

Following its FY25 result, Macquarie tips more than 40% upside for this ASX All Ords mining stock

Let’s dig into why this is such an exciting stock.

Read more »

Female miner smiling at a mine site.
Resources Shares

Macquarie forecasts 30% upside for this ASX All Ords mining stock

If a broker is right, investors have a lot to gain with this stock.

Read more »