Yield Trap Calculator

Usually not without scrutiny. For an 8% yield to be covered at a 60% payout ratio, the company must earn 13.3% of its market value every year (8% ÷ 0.60) — a P/E of 7.5, which means the market is pricing in earnings decline. If the payout ratio is 100%, every dollar earned goes out the door and nothing is retained for downturns; at 130%, the dividend exceeds earnings entirely (0.8x coverage) and is being funded from debt or asset sales. An 8% yield can be legitimate — some midstream energy companies and BDCs sustain it — but only when cash flow, not just accounting earnings, covers the payout with room to spare.

For a common stock, a payout ratio above 80% is thin — earnings cover the dividend just 1.25x (1 ÷ 0.80), so a modest earnings dip forces a choice between borrowing and cutting. Above 100%, the dividend is mathematically uncovered: at a 130% payout ratio the company pays $1.30 for every $1.00 it earns, which cannot continue indefinitely. The exceptions are REITs and MLPs, which report high payout ratios by design because depreciation suppresses their accounting earnings — judge those on funds from operations (FFO) or distributable cash flow instead, where 70–85% is the normal healthy range.

Remember that yield is a ratio: dividend ÷ price. When a stock's yield doubles, it is almost always because the price halved — the market voted first. The classic warning cluster: a yield far above sector peers (a 9% yielder among 4% peers), a payout ratio drifting past 100%, declining revenue or earnings for several consecutive quarters, and rising debt used to sustain the payment. Any one alone can be noise; two or more together usually precede a cut. Checking the trend matters more than the snapshot — a payout ratio that climbed from 55% to 95% in three years is riskier than one steady at 75%.

Only if the fund generates 12% plus its expense ratio in total returns every year — and equity markets have averaged roughly 10% annually over the long run. When a covered-call ETF distributes 12% but earns 8%, the extra 4 points come out of net asset value, so the share price grinds lower and next year's 12% is paid on a smaller base. A fund distributing 12% while its NAV falls 4% per year delivers a real income return closer to 8%, shrinking in dollar terms over time. The calculator above measures exactly this: distribution yield minus NAV erosion, which is the number that determines whether the income lasts.