The Motley Fool: Yield trap or treasure?
Ask the Fool: Yield trap or treasure?
Q: What’s a yield trap? — H.C., Greenville, North Carolina
A: Imagine running across a stock with a dividend yield in, say, the double digits. That’s unusually high, and it could be that you’ve found a terrific source of reliable investment income — or you might instead have stumbled upon a yield trap, tied to a company that’s facing challenges. It might end up shrinking or eliminating its dividend — and its share price could fall, too.
Remember that a dividend yield is simply a stock’s annual dividend amount divided by its current stock price. So a $25 stock paying $1 per year in dividends would have a dividend yield of 4% (because 1 divided by 25 is 0.04, or 4%). If the company gets into trouble and its shares fall to, say, $8 per share, its yield will suddenly be 12.5% (1 divided by 8 is 0.125, or 12.5%). That yield would draw a lot of attention. But the stock could keep falling (and the yield rising) — until, perhaps, the dividend is eliminated.
Take a close look at any high yield that attracts you. For example, check what percentage of earnings is being paid out in dividends — that’s the “payout ratio,” and you don’t want it close to (or above) 100%. (Less than around 55% is preferable, in general.)
Q: What does “baked in the cake” mean? — B.W., Saratoga, New York
A: In the investing arena, it refers to an expected result. For example, you might see a company post a terrible quarterly earnings report without its stock price falling. That’s likely because the poor results were “baked in the cake” — already expected, and factored into the stock price.
Fool’s school: Keep your financial life safe
It’s important for all of us to tend to our finances regularly — and to keep them safe. Failing to do so can lead to headaches and possibly even financial losses. Here are some tips:
- Only share your Social Security number (SSN) when necessary, when asked for it by a reputable company that truly needs it (such as a bank running a credit check before lending to you). Don’t print the number on your checks, and don’t carry your Social Security card on you, lest it get lost or stolen. Don’t share your SSN or other information with any people who call or email you — you should initiate the contact.
- Before throwing away any financial documents with your personal information (such as your full name and address, account number or SSN) on them, shred them.
- You can opt out of receiving unwanted credit card or insurance offers in the mail by calling 888-567-8688 or visiting OptOutPrescreen.com. It’s smart to shred any offers you get so identity thieves can’t apply for credit cards in your name with them. (Yes, some thieves go through trash.)
- Review statements such as those from banks and credit card issuers regularly to verify that all transactions are legitimate. (You might also spot some recurring charges you can cancel — such as for subscriptions or memberships you no longer use.)
- Don’t use the same password for multiple sites, and avoid easy-to-guess passwords, such as ones featuring birthdates or your pets’ names. Ideally, use a combination of uppercase and lowercase letters, numbers and symbols. It can also be good to use two-factor authentication, passkeys, biometric identification and/or a password manager.
- Use firewalls, antivirus software and/or virtual private networks (VPNs) to guard your privacy online. Secure your home Wi-Fi network, and avoid entering passwords or accessing financial sites over public Wi-Fi networks, such as those in cafes or airports. When shopping online, stick with trusted, established retailers.
You can learn more about any unfamiliar terms above via a quick online search.
My dumbest investment: Patient and deliberate
My most painful investing mistakes involved selling too early. For example, I bought into Chipotle Mexican Grill pretty early, as it was a Motley Fool recommendation, but then I dumped my shares because of the health scare. I netted a decent gain, but nothing compared to what it could have been. I got out of Netflix too soon, as well. I’d multiplied my initial investment but thought the company was slowing and losing ground to its peers — so I missed the big run-up of the past few years. Probably the cream of the dumb crop was buying into cannabis companies at the height of that bubble a few years ago. I’m now a much more patient and deliberate investor. — A.C., online
The Fool responds: Not everyone learns from their mistakes, but you did — so bravo! With situations such as Chipotle’s — when it was linked to outbreaks of norovirus between 2015 and 2018 — investors need to ask themselves whether this is likely to be a lasting problem or a passing one. In Chipotle’s case, it ended up paying hefty fines and spending tens of millions of dollars upgrading its food safety procedures. The stock has averaged annual gains of almost 15% over the past decade. Being more thoughtful, patient and deliberate should serve you well.
(Do you have a smart or regrettable investment move to share with us? Email it to TMFShare@fool.com.)
Foolish trivia: Name that company
I trace my roots back to Chicago in 1894, when a Dutch immigrant with a horse-drawn wagon began collecting trash. His grandson and two others founded me in 1968. By 1982, I was one of the world’s biggest waste disposal companies. Today, based in Houston, I’m a waste collection and recycling titan. I serve more than 20 million residential, commercial, industrial, medical and municipal customers in the U.S. and Canada, offering collection, recycling and disposal services. I own a massive fleet of more than 12,000 heavy-duty natural-gas trucks. I shortened my name to two letters in 2022. Who am I?
Last week’s trivia answer
I trace my roots back to 1898, when 20 paper mills joined forces. I bought the Hammermill Paper Company in 1986, the Federal Paper Board Company in 1995 and Champion International in 2000. Today, based in Memphis, Tennessee, and with a recent market value near $25 billion, I’m a global sustainable packaging giant. I employ more than 65,000 people, operate in more than 30 countries and rake in more than $18 billion annually. I was once the largest private landowner in America, with more than 8 million acres of forestland and some 19 million acres worldwide. Who am I? (Answer: International Paper)
The Motley Fool take: A blue-chip stock
Coca-Cola (NYSE: KO) has been around for 139 years and encompasses more than 200 brands including carbonated soft drinks, sports drinks, water, juices, coffee, tea, milk and even some alcoholic beverages. Now could be a good time to crack open a stake in this global powerhouse with a presence in more than 200 countries.
Coca-Cola serves customers who are pretty brand loyal, so it’s not likely to take a big hit in a recession. The company has delivered years of resilient growth through economic downturns and even a long-term domestic trend away from both sugary and diet soft drinks. It’s also largely insulated from the current trade war because most of its products are bottled and distributed in their home countries, often through independent bottlers. Coke is just collecting its lucrative piece of the action, as its net profit margin has remained north of 20% over each of the past six years.
Part of the reason for Coca-Cola’s share-price resiliency is its solid performance in 2024. Global case volume grew slightly in 2024 and organic revenue grew by 12% year over year. For 2025, management projects organic revenue growth of 5% to 6%.
The stock’s valuation is not a screaming bargain at recent levels, but it’s reasonable. The dividend was recently yielding 2.8%, too, offering investors a stream of reliable income. And that payout is growing — Coca-Cola has upped its dividend for 63 consecutive years.
— distributed by Andrews McMeel Syndication
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