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High-yield stocks often catch the eye of investors due to the seemingly significant, tangible returns on investment. Yet, not all that glitters is gold. In fact, it’s often the case that many names offering outsized yields are attached to a number of risks. Some mask such lurking risks beneath their attractive yields, these are known as dividend yield traps.
A yield trap occurs when a stock’s dividend appears enticingly high, often above the industry average or historical norms. Yet, what one can initially perceive as generosity can often be misleading, as it might stem from factors such as a declining stock price or unsustainable payout ratios rather than a high-payout business with healthy financials.
In my early investing journey, I found myself falling into yield traps. Over the years, I have seen both novice and seasoned investors alike often make the same mistake. Below, I share three dividend yield traps whose high yields should be approached with caution.
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Leggett & Platt (LEG)
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For some, it may be a bit surprising that I am including Leggett & Platt (NYSE:LEG) as a possible yield trap. This is because income-oriented investors hold this old furniture and bedding manufacturer in high regard. Having grown its dividend for 52 consecutive years, Legget & Platt has certainly earned the trust of investors seeking reliable payouts. Yet, I believe that its dividend growth streak may soon be coming to an end.
The very fact that shares of Legget & Platt have plunged by about 45% over the past year alone directly illustrates investors’ growing concerns. What underlies these concerns? It’s the company’s stagnant sales, declining margins and shrinking profits.
Increased competition in the space led to the company posting an 8% decline in sales last year. The decline in sales, along with the low-margin nature of the business, led LEG’s EBIT margin to turn negative. Thus, the company posted a loss per share of $1.00 for the year. This was the first occurrence of a GAAP loss in its publicly available data dating back to 1991.
Therefore, despite its legendary dividend growth track record, think twice before you jump Legget & Platt’s seemingly attractive 10.5% dividend yield.
Vodafone Group (VOD)
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Vodafone Group (NYSE:VOD) is another name that is a potential yield trap. The UK-based telecom giant has experienced a continuous decline in its shares over the past decade. This trend has picked up in the past couple of years, as Vodafone’s mounting debt in the face of a rising rates environment has eroded investor confidence in the stock.