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

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.

The post Are Fortescue shares a buy for income or are they a dividend trap? appeared first on The Motley Fool Australia.

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• What’s driving the Fortescue share price to an 8-week high today?
• The iron ore price has slumped 10% in 5 days. Here’s how ASX 200 mining shares have responded.
• Up 5% in a month, is the current Fortescue share price a buy or a sell?
• ‘World’s greatest concern’: Can Fortescue really help the planet AND its profit margin?

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.

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