Income trap? Don’t be fooled by this ASX dividend share’s 8% yield

If you stumble across an ASX dividend share trading on an 8% dividend yield, what would you do? I hope the answer is to look for a reason why.

We all love a good dividend yield. Dividends represent real returns on an investment, and a valuable source of passive income and investing cash flow. So logically, the higher the yield, the better, right? Well, usually not. The market always prices a share on a risk-reward spectrum. And when it comes to dividend shares, a good rule of thumb to use is ‘the higher the dividend yield, the higher the potential risk’.

If an 8% dividend, for example, is viewed as secure and reliable, investors will seek it out, consequently increasing the price of that company’s shares and lowering its dividend yield until the supply and demand balance out. If it is viewed as potentially unreliable, however, there will be fewer buyers, and thus, a higher yield will be on offer.

Let’s check out a popular example of this phenomenon in action.

Shares of listed investment company (LIC) WAM Research Ltd (ASX: WAX) are currently trading on a dividend yield of 8.16% at the time of writing. At first glance, that yield checks out. WAM Research has funded two dividends over 2025. The first was the interim dividend worth 5 cents per share, paid out in April. The second was the 5 cents per share final dividend that we saw hit investors’ pockets in October. Both payments came partially franked at 60%.

At today’s WAM Research share price of $1.22, that 10 cents per share in annual payouts gives this ASX dividend share a trailing yield of 8.16%.

An ASX dividend share with an 8.16% yield?

But remember, an ASX dividend share’s trailing yield reflects the past, not the future. No ASX share is guaranteed to pay the same level of dividends as it did in a previous year.

So let’s check out why the market is pricing WAM Research with such a high dividend yield.

A few days ago, this ASX LIC released its latest monthly report. This revealed that the net tangible assets (before tax) of WAM Research’s underlying investment portfolio came in at $1.04 per share as of 30 November.

That happens to be less than what the company had five years ago. Back in November 2020, WAM Research reported a pre-tax NTA of $1.13 per share. This means that this LIC’s portfolio has lost value over a period that saw the S&P/ASX 200 Index (ASX: XJO) climb almost 30%. Over those five years, WAM Research has dutifully collected its management fee of 1% per annum (plus GST, of course), though.

We can see this reflected in the WAM Research share price. As it stands today, the company is a nasty 20.45% below where it was trading at five years ago today.

So clearly, WAM Research isn’t actually growing its underlying holdings, yet paying out a large dividend every six months. The market arguably views this as unsustainable, which would explain this ASX dividend share’s outsized 8% yield right now.

In my view, this is a classic income trap and should be avoided by anyone who wishes to protect their capital.

The post Income trap? Don’t be fooled by this ASX dividend share’s 8% yield appeared first on The Motley Fool Australia.

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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.