Lesson 4.4 · 4 of 5 · Dividends in depth
The high dividend yield trap: warning signs of a dividend cut
The high-dividend trap is when the yield climbs because the share price is falling, and the company can no longer afford the dividend. The warning signs usually come first: the dividend exceeds profit, free cash flow stops covering it, debt rises. GE, Intel and Vodafone all cut after signs like these.
Terms in this lesson
- Dividend yield
- How much the company pays you each year in dividends, compared with the share price.
- Payout ratio
- The part of profit that goes to shareholders as dividends.
- Free cash flow (FCF)
- The cash left to the company after it pays for its investments.
- Net debt
- The company's financial debt minus the cash it holds.
Why a high dividend yield can be a trap
Watch out
What actually happens?
You lose twice: on the price and on the income.
The yield rises on its own when the price falls, without the company paying a penny more. If whatever knocked the price down is real, the company then cuts the dividend. Anyone who bought for the high yield is left with cheaper shares and a smaller income.
When a dividend is halved, the real yield halves too.
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Create a free accountReal dividend cuts: GE, Intel and Vodafone
| Company | Before | After | Announced |
|---|---|---|---|
| General Electric | $0.24 a quarter | $0.12 (-50%) | 13 November 2017 |
| General Electric | $0.12 a quarter | $0.01 (-92%) | 30 October 2018 |
| Intel | $0.365 a quarter | $0.125 (-66%) | 22 February 2023 |
| Intel | $0.125 a quarter | Suspended from Q4 | 1 August 2024 |
| Vodafone | 15.07 euro cents a year | 9.00 (-40%) | 14 May 2019 |
| Vodafone | 9.0 euro cents a year | 4.5 (-50%) | 15 March 2024 |
From the companies’ announcements (SEC; for Vodafone, its annual results released to the London Stock Exchange). Vodafone announced its second cut alongside the sale of Vodafone Italy and confirmed it with its results on 14 May 2024; 4.5 euro cents is the dividend for the financial year to March 2025.
The reasons the companies gave sound alike: GE wanted to “align our dividend payout to cash flow generation”, Vodafone to rebuild headroom against its debt, Intel to give itself more financial flexibility for investment. Each time, the problem was already visible in the figures.
Warning signs of a dividend cut
- The dividend exceeds profitA payout ratio above 100% for several years running, not just in one year with a one-off charge.
- Free cash flow no longer covers itOperating cash flow minus investment is smaller than the dividends paid.
- Debt keeps risingNet debt climbs year after year, and the extra borrowing seems to be funding the dividend.
- The yield is far above the sectorTwo or three times what similar companies pay, after a big fall in the price.
Real case
Intel in 2022
Payout ratio: 75%. Free cash flow: negative.
In 2022 Intel paid dividends of $1.46 a share on earnings of $1.94: a 75% ratio, which looks reassuring. But operating cash flow was $15.4 billion and net spending on factories and equipment $23.7 billion. Free cash flow was negative, -$8.3 billion, while dividends paid came to $6.0 billion. Less than a month after those results, Intel cut its dividend by two thirds.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: General Electric, announcement of 13 November 2017 (dividend cut from $0.24 to $0.12, John Flannery’s quote) and third quarter 2018 results (30 October 2018, cut to $0.01); Intel, full-year 2022 results (26 January 2023, SEC: EPS $1.94, operating cash flow $15,433 million, net additions to property, plant and equipment $23,724 million, dividends paid $5,997 million, dividend $0.365), Form 10-K for 2022 (dividends $1.46 a share), announcement of 22 February 2023 ($0.125, “financial flexibility”) and second quarter 2024 results (1 August 2024, dividend suspended); Vodafone, annual results of 14 May 2019 (9.00 euro cents against 15.07; net debt €27.0 billion), announcement of 15 March 2024 (sale of Vodafone Italy; dividend rebased to 4.5 euro cents from financial year 2025) and annual results of 14 May 2024 (9.0 euro cents for financial year 2024).