The Dangers of Dividend-Trap Stocks

Let's do it. We will start out with a quote. Successful dividend investing is not about finding companies that pay dividends. It's about finding companies that can afford to keep paying and have attractive valuations. We'll get into that in more detail later on. This column, today's session, Successful Dividend Investing: How to Avoid Dividend Trap Stocks. I'm Kyle Guskey II. We're here with David Trainer. Start off disclosures and disclaimers. The important one is we are not providing advice. We are providing research. We'll have this at the beginning of the replay as well. But we'll start off with a quick rundown. We're combining this one with, you know, normal time slot of our monthly podcast. So we'd like to mention What we've got going on each month, we do a podcast specifically about topics that are submitted by the community. I'm combining that into the dividend training today. The next podcast, monthly podcast we'll have will be on July 18th. We'll figure out the topics for that as we go. So our community's talking about what's going on in the market, bringing you the most relevant topics going on, combined with the research we've put out. Since we last did the specific podcast, we've met a whole bunch of other times, many live sessions. Dangers of fake dividend stocks, dangers of false dividend stocks, done multiple different earnings watch replays, some live podcast content that's gone out as well. But we put out multiple new long ideas, some danger zone updates, long idea updates, and then a lot of position close updates. We're looking at some of the older long idea danger zone picks maybe that have worked, haven't worked, that no longer provide the same risk reward that they once did. That's— we're closing those out. Some of them have been focus list stocks we've removed from the focus list. I've also made some other updates to the focus list as well on those model portfolio updates down at the bottom there. Since last month, we've also updated all of our model portfolios, the most attractive, most dangerous, things that compound with ROIC, safest dividend yields, dividend growth stocks. And then we've given out a whole bunch of free picks on those model portfolios as well. Each week we feature a stock from one of those portfolios to give all of our readers a little bit of insight into the kind of stocks in those portfolios, as well as the kind of research we do, how we look at cash flows, how we look at valuation. It's a quick, brief kind of snippet into the longer Long Ideas and Danger Zone reports. But as for today, we're gonna talk briefly about some special webinars and trainings upcoming, and then we'll jump into the dividend trap stocks portion of our presentation. And then at the end, we can take some questions. You can send us questions anytime. And if there's time permitting, we'll take some ticker requests from the audience at the end as well. Can run it through the system, look at dividend, look at, you know, fundamentals. So if you want to get those tickers into the chat or Q&A here, we'll be able to gather those and talk about them at the end. On the special webinars and trainings, we have 2 upcoming. First one, they're actually both on the same day. But the first one is What Most Retirees Miss. The Dividend Shortcut Investors Are Using to Win 2025. That will be next Tuesday at 1:00 PM Eastern. And then we also have an Ideas Dinner for Pro and Institutional members only. That'll also be Tuesday, June 17th at 4:00 PM Eastern. David joins the Pro and Institutional members, deep dive on our long ideas, any ideas that they might have, they can discuss and look through the system and take a nice deep dive into those.

Those Idea Dinners have been very— there's been some really good ideas come out of those and some pretty interesting findings. We found a quantum computing stock that actually made sense. We didn't think it did at first, but then it did. And then one of our best stock picks in the last few years, I think, came out of that a while ago too. So a lot of fun. We do the reverse DCF, we dig into the deep stuff. So that's a great meeting. And I hope all the pro members have a chance to experience that. Pro and institutional, it's tremendous. And then You know, the training on earlier in the day is going to be— that's going to be a good one. I'm really looking forward to that. We've been building up to that for a while, but we're going to be building up to that some today as well.

Yeah. And it goes with the recent trainings there, fake dividend stocks and false dividend stocks. Everyone thinks of dividends as the safe haven investment, but not all of them are. We're kind of walking everyone through the dangers of dividends. So we'll make these slides available in our community with the replays. You can get those links. I can also send them out once I turn it over to David, but We will jump into today's topic, the successful dividend investing, how to avoid dividend trap stocks. I'll throw it over to you, David. You want to share screen? You want to click, and I'll put some links into the chat.

I always want to hear from you in the chat. We love taking questions and also requests if we've got time at the end. But let us know who you are, especially if you're a first time with us. We'd like to know that. I've seen some folks that are with us, have been with us for a long time, and some of you I haven't seen for a while. So, welcome back. Look, we've done a deep dive on what retirees and what dividend investors miss in the market these days because I think there's this false mythology around dividend investing being simple, straightforward. Just go buy the dividend stocks. Those are safe. And that's just not the case anymore. Nothing in this world is as easy as it used to be when it comes to investing. All the easy stuff has been taken advantage of a long time ago. And what seems easy today is actually very dangerous because what seems easy is to follow the crowd, momentum, YOLO, MOMO, meme stocks, whatever. And that's actually very, very dangerous as I think we're going to see through the rest of this year. We've already seen a lot of volatility this year. And I think we're going to see more. There are just too many things out there that got to continue to go exactly right in order for this market to hold up. And we are walking on sort of the primrose path of Goldilocks on top of Goldilocks on top of Goldilocks. And we'll get into that more a little bit next week. Today, I'm just going to focus on helping you understand that the dividend strategies are not always the safe havens that people think. And Kyle put the registration in there for this training we're going to do next week. So let's talk quickly about fake dividend stocks or bad dividend stocks. We've established that not all dividend stocks are good, right? And not all stocks are good in general. I mean, it makes sense. But you got the fake dividend stocks. These are companies that are using dividends as smokescreens for bad stocks. They're going to brag about a big dividend, but it's not necessarily safe and it's not necessarily going to justify how much downside the stock has. Well, or the company has because it's gonna get a bad rating in general. It's gonna have poor economics and an expensive stock price. Last week we talked about false dividends. These are companies that can't actually afford to pay their dividends. You should check out the report on this. It's awesome. It shows their free cash flow was negative $5 billion, but they paid out $1 billion in dividends. It's a negative $6 billion difference. Guess what? They issued about $5 billion in debt and another billion dollars in stock. So, they're just diluting you by paying a dividend. Or they can't keep issuing debt, which, by the way, if you notice, it's a lot more expensive these days. They're going to have to cut the dividend, but they just don't have the cash flow to support it. Those are super risky too, because when you cut a dividend, you're going to see a major cut in the stock price. People aren't going to be like, oh, dividend just got cut. No big deal. Keep going. No. The dividend goes down and the stock goes down in a big way. This week we got the trickiest of them all, the dividend trap stocks. So dividend trap stocks have low yield but high risk. And when you look at the overall market, there's a lot of them. 13% of the stocks we cover are dividend trap stocks. That's a pretty good amount. To define a dividend trap stock, it's a company that kind of looks good on the surface. They got pretty good economics. Sometimes great economics. They can afford to pay their dividend. The issue is not the dividend. The issue is the risk in the stock price. The high valuation of the stock undermines the value of the dividend entirely. If the stock falls more than the dividend yield, then you will lose. The yield isn't enough, isn't high enough to make the risk worthwhile. So all the dividend trap stocks are typically kind of some of these bigger companies, That look safe. They don't pay a huge dividend. It's going to be below the 5-year zero coupon rate yield, which is around 4%. So, we're not talking about huge dividends. You can't have a huge dividend yield when the stocks are that expensive anyway. So, you're talking about lower dividends in general, lower dividend yields, but very, very expensive stock prices. So, you don't have a lot of margin of safety there. If you're only getting a 1.5% dividend, And the stock goes down 5%, you're losing a lot. Example number 1, WD-40, $244 a share, a 1.5% dividend yield. Clearly not a sexy, popular dividend-paying company because that's not a yield that a lot of people are going to get out of bed for. But it is a dividend trap stock because it is paying a dividend and it might be an important part for some people. This company's been around for a while. But when we go a little bit deeper, we're going to see, yeah, quality earnings, check, check, check. $82 million in NOPAT, 21% ROIC, $55 million in economic earnings. Making plenty of money. But the problem is the stock is super expensive. A 3.1 price-to-economic book value. That means like 2/3 of the stock price Is based on future growth. So that means that a huge amount of growth is priced in. Only $80 out of that $244 is accounted for by the current cash flows of the business. Everything else is based on the future, right? $80 is about a third of $244. So $80 is solid. We got that in the bank. The other $160 is all based on the future. It's on the come. You don't know you're going to get it. That's a lot of risk. So guess what? Stock barely misses on earnings. What's going to happen? It's going to get crushed. That 1.5% dividend payout is going to look like nothing. Not surprisingly, at the same time, we're going to see that the market implied growth appreciation period, that's a really high number. It takes over 100 years. In other words, that's a way of saying that it's going to take— if you assume that the company does roughly what it's done in the past, They'd have to do that for more than 100 years to earn that $160 of growth. That's 2/3 of the current stock price. So we're seeing a very expensive stock in general here. So that's a great example of a dividend trap stock. Taking a look at the rating, quality of earnings. So you shouldn't be surprised here, right? Quality of earnings. Strong, strong valuation. Weak, bad, very bad. 3.1. There's that price to economic book value I showed you. And here's that 100-year market implied growth appreciation period, more than 100 years. For those of you that are not familiar, this market implied growth appreciation period analysis is based on a reverse DCF model. And it is probably one of the most sophisticated valuation models you're going to see ever in the marketplace. And it actually goes through the work of saying, okay, what does this company have to do to justify the current stock price? And in this situation, it's again, it's more than, more than 100 years of growth and profitability at roughly the same rate of what we've seen in the past and consensus, consensus numbers. So this is a great example of a dividend trap stock. And our report that's going to be published on Monday, you're going to get 2 more examples. If you saw our report last week, At our webinar last week, the additional examples in the report were way worse than the one that I talked about last week. And so I'm expecting we're going to see something similar this week as well. But we definitely make sure you check out that report and make sure you check out and register for the webinar. Any questions about dividend trap stocks?

I was just going to jump in and say last week's report is also free on the website, the same as the one coming out Monday. So that would be anyone that is signed up for our email list, you know, can get that.

That's right. So next week on Tuesday, I'm not only going to talk about the fake, false, and dividend trap stocks, but I'm going to show you how to find the best dividend stocks. I'm going to give you the AI-driven shortcut that's going to help you win in 2025. And it's, it's shortcut for you. It's a long cut for us. We spent a lot of time and energy building out the AI. So that we could get reliable financial information and have best-in-class ratings and best-in-class data. But to summarize, 3 kinds of bad dividend stocks. You want to know them all: fake dividend stocks, false dividend stocks, dividend trap stocks. And then the good dividend stocks we'll talk about on Tuesday the 17th at 1 PM Eastern. All right, any questions here, or requests for us to look at particular tickers. If you're interested in getting the best dividend stocks right now, I'll show you how to get them. Just click here. Safest dividend yields. Safest dividend yield stocks. This is a model portfolio of about 20 large and small cap stocks that have safer dividend yields because of super strong free cash flow. And every stock also gets our attractive or very attractive rating and has a dividend yield greater than 3%. That's what we like. Or you can get our dividend growth stocks model portfolio. This has about 30 of the best of the best among dividend growth stocks based on their dividend growth track record and potential for future dividend growth. All these stocks have an attractive or very attractive rating, positive economic earnings, and free cash flow and have increased dividends for at least 5 consecutive years and have a dividend yield of at least 1%. These are the best dividend stocks. You can get them right now. And I think one of the big takeaways about New Constructs and what we're doing with dividends and what we're talking about and why we're focusing on this is that we believe you deserve the best of both worlds. You shouldn't just have a good, high dividend. And a bad stock or a good stock and a bad dividend, good stock and a low dividend. You deserve the best. And the only way to get that is with our diligence and with our research. Alrighty, let's, let's take a look at— it's never going to make— it's not going to let this stuff go away here. This little scribble. What do I got to do to get rid of that? Where's the clear? Oh, here we go. All right. We got some requests to take a look at here. Let's go with the first one, North America Construction Group. I'm not showing a dividend here at all. It's a neutral rating. Interesting. So you got okay business, but you know, you got some lumpy cash flow here. You got cheap valuation. This one's sort of all over the board. But what I would point out most here, first and foremost, is suspended rating, weak internal controls. This is a big red flag. I would highly avoid stocks where we see weak internal controls. That's when the auditors are raising a red flag saying, we're not sure about the data. We're not sure about the data. We don't trust the company to have given us enough accurate information to have an opinion that we feel is 100% reliable. That's pretty scary. That's pretty scary. I'd recommend Avoiding this one altogether, even though just the neutral rating, that gets a little bit scary. Interesting. Credit rating, not so good. A little worse than the stock. All right, let's take another one.

GSK.

I feel like we get this one requested a lot. Go to the stock rating. 4% yield and an attractive rating. Not so bad. Roger, any other questions about that? It looks pretty good. No. Looks pretty good. Decent business, cheap valuation. Stock price implies a permanent 10% decline in profits, a less than 1-year market implied growth appreciation period. I like it. Break it down a little further. Interesting. You notice how economic earnings are much more stable, right? Accounting earnings up too much, down too much, up too much, down too much. Happens all the time. Economic earnings take out all the noise, and you'll see that time and time again. You'll see that also with our earnings distortion and core earnings analysis. Look, core earnings, similar, less volatile, consistent track record to economic earnings. Return on invested capital looks pretty good, pretty steady. See a bunch of stats here, return on capital, how it's doing. Margins look a lot like accounting earnings, huh? But you can see how the decline in the margin has been offset by capital turns. So that's part of why you're seeing the economic earnings do better than accounting earnings and return on capital stays steady despite a pretty significant drop in margins. What are you seeing here? Mid-20s to high teens, high 20s to mid-teens. So this is probably something the market is missing. Most people are not looking at the balance sheet and capital returns. Free cash flow, that's pretty strong. That's really strong. 40% yield. Mostly mid-single digits. It's impressive. Free cash flow margin, also pretty strong. Price to economic book value, interesting. Stock price is staying pretty steady, economic book value coming way down. So I would have to say, you know, looking at this, for me to make a case to buy something like this, I'd want to go in and take a look at the business and say, okay, is there any growth potential here? Or are we just going to see profits continue to go down? Does the market have it right? Is an additional permanent 10% decline in profits likely?

Yeah, I was going to say, is that 10% warranted? Like, there could be structural issues or something that, you know, a 10% drop might not seem as drastic when you look at the trends in the business.

That's exactly right, because you're seeing the economic book value headed down. Not so great. All right, let's take one more, and we're going to cover a little bit more about new constructs in a second. Let's go. Who was next here? CEG, Constellation Energy. So, Frank, you're asking about this because these guys are in the conversation around some nuclear and data center stuff. Am I right about that? I think I've heard these guys' name banded around on that. I think, you know, the takeaway for me and this stock is that, yeah, it's a crowded trade. And I think it's really important, everyone, to understand crowded trades. Crowded trades are the Mag 7. Crowded trades are the major indices. Crowded trades are those strategies that look easy but are very risky. It looks easy for a reason, folks, because everyone can do it. But can everyone make money in the market all the time? No, no. So you got to do something different if you want to succeed. Constellation Energy, very expensive stock. And yeah, this is a good example of kind of a bad dividend stock here as well.

We've also got the suspended rating. Financials could look significantly different once they complete the acquisition.

That's right. Yeah, big acquisition. That's always kind of risky for us. We don't really like stocks that do big acquisitions because it's rare that they actually create value, really rare. Very rare, and so yeah, suspended rating. And if you ever want to know how to get answers on suspended ratings, you just click on this. We're going to put that into on all ratings pages, but I'm going to put the link to the suspended ratings because I get questions about that every now and then. All right, let's cover a few more slides and we're going to finish up here. Let's talk a little bit more about what makes new constructs special. Why are we able to do this better work? It comes from my experience on Wall Street, seeing how the sausage is made. I was there before the tech bubble, during the tech bubble, after the tech bubble, and I saw a severe decline in analytical rigor that has continued over the last 20 years. We're doing something better. That's why we've been ranked number 1 on SumZero for 48 straight months. That's 4 years in a row, every month for 48 straight months. We've been ranked number 1 in multiple categories. No other research firm. And I always say, free report of your choice on any ticker you want to anyone who can show, or to put into the chat, another research firm that's had multiple papers published vetting them and validating the superiority of their data. Also let me know another research firm that's got live indices trading based on their data that are outperforming the Very Attractive Stocks Index. You think our ratings matter? The Very Attractive Stocks Index, it's an index based only on very attractive stocks, beat the S&P in the first quarter by over 9%. Over the last 5 years, it's beat by about 80%. The Core Earnings Weighted S&P 500, this is you take the S&P 500 and instead of weighting stocks based on market cap, you weight based on core earnings, right? We'll let somebody else pick the stocks, we'll still beat them just because we'll weight more intelligently. This beat the S&P 500 by 1%, by 1%. I mean, how much better would you feel if you're weighting stocks based on some true superior fundamental metric? Isn't that better? Core earnings weighted S&P 500 has beat the S&P 500 by 33% in the last 5 years. The legacy S&P 500, I like to point out, that's the old legacy, the old 500. We're bringing in a new 500. These indexes are managed by Bloomberg, so you can look them up as well. They're not available for the public to purchase. They are all based on our research. And the only place you can get this kind of alpha and where you get this, where you can get this kind of data is from us at New Constructs. Alrighty, that brings us to conclusion here. Thanks everybody for being with us. If you don't have any more questions or requests, I think we will wish you a very happy weekend.

Thank you.

Thanks for being with us, and we look forward to seeing you on Tuesday.