MILLBURN, N.J. ( Stockpickr) -- Beware of dividend traps.
Dividend traps are stocks that entice investors to take an investment position based on cheap valuation and above-average dividend payouts. Unfortunately, what the investor learns is that the value received from the dividend is more than offset by the depreciation in value of the stock price. In other words, total returns to investors are negative.
There are several characteristics that dividend trap companies share. One or more of the following will be evident for dividend trap companies:
- Dividend yields are at least 100 basis points above that of the S&P 500.
- The companies tend to operate in a business or segment that is in secular decline -- that is, these are businesses that find that their products are becoming obsolete or irrelevant in the economy.
- The companies have poor management.
- Second Banana Syndrome: These are just inferior companies within their industry.
- Increasing dividend payouts to help shore up the stock price.
- Their PEG ratios - price to earnings adjusted for growth are negative or extremely large