Fortescue’s huge dividend yield a classic dilemma

Investors must front some textbook sharemarket conundrums in deciding whether shares in Pilbara iron ore miner Fortescue Metals are a screaming bargain or capital killer.

Another brutal round of selling on Friday took the stock down 42 per cent from a July 29 high of $26.58 to a 52-week low of $15.27.

On that valuation, the miner’s trailing dividend yield equals an eye-watering 23.4 per cent, plus the tax benefits of full franking credits based on FY2021 dividends of $3.58 per share. The dividend bonanza showered US$8.2 billion ($11.2 billion) in cash on shareholders over the year.

However, two of the most common investing mistakes are catching a falling a knife and buying a business based on its trailing dividend yield.

An extraordinarily large yield is often a sign the market expects a dividend cut, while a beaten-up stock price is a traditional red flag to experienced investors. This is because stock prices reflect the forward expectations of markets, which logically means past prices have no bearing on future returns. In fact, tumbling prices normally reflect expectations of bad news ahead.

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