Warning: These 2 ASX shares could be dividend traps

MotleyFool
17 Mar

One of the biggest mistakes income investors can make on the ASX is buying into a dividend trap.

A dividend trap occurs when an investor buys up a share of a dividend-paying stock, expecting to receive the level of dividend income that its current dividend yield indicates. However, the dividend stock in question then goes on to cut its dividends compared to the previous year's payouts, thus lowering the dividend yield going forward. 

The investor, who was expecting a high yield, receives the lower yield, and also has to potentially deal with a share price fall stemming from the dividend cut, trapping them in a situation where they either have to accept their lower income, or sell out of their investment at a capital loss. It's not a situation that investors want to find themselves in.

Today, let's discuss two ASX dividend shares that I think are putting anyone who buys shares today in danger of experiencing this phenomenon.

Two ASX income shares that could be dividend traps

Woodside Energy Group Ltd (ASX: WDS)

First up, we have ASX energy stock Woodside. Woodside is the largest energy stock on the ASX, with significant global operations in oil and gas production. Looking at Woodside shares today, one might be attracted by the seemingly-monstrous 8.2% dividend yield. A yield, we might add, that typically comes with full franking credits attached.

However, I think that no one buying Woodside shares today should expect an 8.2% yield on their capital.

Like any energy or oil share, Woodside's ability to generate profits, and thus fund dividend payments, rests almost entirely on the price of oil itself.

As it happens, oil prices have been falling quite spectacularly in recent months. Back in mid-January, one barrel of Brent crude oil was going for just over US$82. Today, that same barrel is worth just $US$71.70.

Last week, my Fool colleague Bernd discussed how analysts at Citi expect Brent to fall as low as US$60 a barrel over the rest of 2025, with a US$50 per barrel price in the realms of possibility too. This is mostly thanks to US President Donald Trump's plans to expand energy production in the United States to lower prices.

If this situation eventuates, you can bet that Woodside shares won't be yielding anything close to 8% over 2025.

WAM Capital Ltd (ASX: WAM)

WAM Capital is a listed investment company (LIC) that is particularly popular amongst retirees and other dividend investors on the ASX. This is thanks to this LIC's long habit of paying out fat dividend payments to its investors. Looking at this company's current dividend yield, and it's not hard to see why. WAM Capital has paid out two dividends over the past 12 months, both worth 7.75 cents per share.

At the current share price of $1.64, these two payments give this LIC a trailing dividend yield of 9.45%. Pretty compelling, right?

Well, things don't look quite as rosy if we scratch the surface a little.

In its most recent monthly update, WAM told investors that its profit reserve (from which it funds dividend payments) was sitting at 24.9 cents per share. Given the company doled out 15.5 cents per share in dividends last year, this means that WAM Capital only has enough cash to fund another 18 months of dividend payments or so. Unless the company is able to generate enough revenue to expand this reserve, this dividend looks like it is on shaky ground.

Of course, WAM can always sell its underlying holdings to generate cash to fund this generous dividend. But this strategy can backfire. Over the past four years or so, WAM Capital shares have dropped by more than 23%, indicating that the company is sacrificing its capital to fund its dividend payments. That's not exactly a recipe for long-term success.

As such, I think there is a high risk that buying WAM Capital shares today will result in a dividend trap situation.

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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