Watch out for worth traps in relation to dividend shares!

I’m an enormous fan of dividend shares. Not as a result of I spend the earnings they supply on discretionary issues like holidays or one-off treats. As a substitute, I exploit it to purchase extra shares, serving to to compound my positive aspects.

The chief government of LondonMetric Property — newly promoted to the FTSE 100 — not too long ago stated: “Revenue compounding is the eighth marvel of the world — the key sauce and the rocket gasoline that creates wealth.”

The most typical technique used to establish earnings shares is to match dividend yields. It stands to motive that these providing probably the most beneficiant returns are those to purchase, proper?

Not essentially.

Some might be worth traps, showing to supply good worth when in actuality the other is true.

A pinch of salt

Enwell Power is an effective instance.

Some league tables are exhibiting this inventory as yielding 86%! However take a more in-depth look and all shouldn’t be what it appears. The corporate is an oil and fuel explorer in Ukraine. As we speak (10 June), its shares are buying and selling at 17.5p. It final paid a dividend of 15p in June 2023. And that is getting used to calculate its yield. Nonetheless, since then the warfare has severely impacted its operations and the federal government has suspended two of its licences. I don’t imagine one other dividend might be paid quickly.

In Might, Vodafone introduced that it was reducing its dividend by 50%. The Hargreaves Lansdown buying and selling platform continues to be quoting a yield of over 10% for the inventory whereas it ought to be round 5%.

Wanting again

As with every funding, I feel it’s important to do a number of analysis earlier than selecting dividend shares.

Sadly, no one can see into the longer term.

Historical past is subsequently the most effective instruments obtainable. However there’s no assure that previous developments will proceed. As Warren Buffett cautions: “If previous historical past was all that’s wanted to play the sport of cash, the richest individuals could be librarians.”

Entering into the element

Nonetheless, there’s one Footsie inventory with a superb monitor report of returning money to shareholders, one that ought to proceed. Because the chart beneath reveals, Authorized and Common (LSE:LGEN) has elevated its dividend throughout 13 of the previous 14 years. The monetary companies supplier stored it unchanged through the pandemic.

Admittedly, it needed to make a reduce through the 2008-09 monetary disaster. However through the previous 25 years it’s solely lowered it twice.

Primarily based on its payout for the yr ended 31 December 2023 (FY23), it’s at present yielding over 8%. That compares to the typical for the FTSE 100 of three.8%.

Analysts are predicting earnings per share (EPS) of 23.31p for FY24. This implies the inventory at present trades on a a number of of 10.6 occasions ahead earnings.  

However to take care of a wholesome dividend, an organization must develop its earnings. Analysts predict EPS to extend to 25.96p (FY25) and 28.25p (FY26).

Nonetheless, the corporate is delicate to macroeconomic circumstances each within the UK and US. For my part, any signal of inflation rearing its head once more or rates of interest being elevated would adversely affect its income and share worth.

However as a result of the shares look to supply good worth and as a result of wholesome dividend, I’m going to maintain Authorized & Common on my watchlist for once I subsequent have some spare money.