At face value, finding the best ASX dividend shares seems easy. You just do some research, find the companies with the highest dividend yields, and start making passive income. Easy, right?
Well, good dividend investing isn't that simple. And in fact, following this 'chasing yields' path is probably a bad idea. Actually, it's a horrendous idea – and one that will probably result in mediocre dividend income, while perhaps giving you some nice capital losses.
See, the dividend yields that we normally see quoted for ASX shares are a reflection of the dividends a company has paid out in the past, not what it will pay out in the future. Take what used to be a popular dividend share, AGL Energy Limited (ASX: AGL).
What does an ASX dividend trap look like?
In 2022, AGL paid out two dividends, one worth 16 cents per share, and one worth 10 cents per share. Using the AGL share price of $8.07 that the company ended 2022 at, those two dividends would have given AGL a dividend yield of 3.22%. That's because 26 cents is 3.22% of $8.07.
Today, the AGL share price is going for $6.89 at the time of writing. That should in theory increase AGL's dividend yield because 26 cents is 3.22% of $8.07, but 3.77% of $6.89. If AGL paid out the same 16 cents per share interim dividend in 2023 as it did in 2022, this would be true.
The problem is that last month, AGL announced its interim dividend would come in at 50% of 2022's levels – yep, just 8 cents per share.
As such, AGL's dividend yield is now 2.61%. So any investor who bought AGL shares a month or two ago expecting a dividend yield of 3.22% or 3.77% has now been caught in a classic dividend trap.
They've lost the yield they thought might be coming their way. And, they've had to endure AGL shares' near-15% drop in value over 2023 thus far.
Everyone in the share market loves a good dividend. So when you see a company offering a dividend yield of 8, 9 or even 10%, it should tell you that investors are staying away for a reason.
Let's take a high-yield example now.
WAM Capital Ltd (ASX: WAM) is a listed investment company on the ASX. It paid out two dividends last year, both worth 7.75 cents per share each. That's an annual total of 15.5 cents per share, giving WAM Capital a whopping dividend yield of 9.2% right now.
So why isn't everyone flocking to WAM Capital shares for that kind of return and thus increasing WAM Capital's share price and reducing its yield down to a more normal level?
Well, investors are being put off by something.
High yield doesn't mean high return
It might be this company's performance track record. Even though this listed investment company (LIC) is yielding a massive figure right now, shareholders have only enjoyed a return of 3.7%, an average over the past three years (as of 31 January)
That means that capital losses have more than offset this high dividend yield. And that's without accounting for WAM Capital's 1% per annum management fee either.
Investors would have been far better off investing in an index fund than this company over the past three or five years. What's more, as of 31 January, this company only had 14.7 cents per share in its profit reserve. Yet last year it paid out 15.5 cents per share in dividends.
So no wonder its dividend yield is so high – the market clearly has doubts over this company's future performance potential.
Compare that to an ASX dividend share like Washington H. Soul Pattinson and Co Ltd (ASX: SOL). On the surface, Soul Patts' current dividend yield of 2.8% doesn't look that impressive. But this figure hides much.
It hides how Soul Patts has increased its dividend every single year since 2000, averaging an 8.5% increase per annum. It also hides that Soul Patts shareholders have enjoyed a total return of 12.5% per annum over the 20 years to December 2022.
Sometimes, a small dividend yield can be worth more than a big one. So don't be deceived by the largest dividend yields on the ASX. Some, if not most, of them are too good to be true.
