Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How to Evaluate a Dividend Stock in a Flat Rate World
Transcript
- Lucas: So Luna, the ten-year Treasury is sitting at 4.68 percent as of Friday, the curve is steepening, and yet we've got dividend stocks like Realty Income and Verizon quietly grinding higher this week. That's a setup that would have made no sense a few years ago. Luna: Right, the old playbook said rising long-term yields should crush income stocks. But today we're seeing the opposite, at least for the names with real cash flow. Lucas: Exactly. And I think that's because the market is finally getting more selective about what counts as a 'dividend stock.' It's not just about the yield anymore. It's about whether that dividend is actually sustainable. So today I want to walk through a few names and a simple framework you can use to check any dividend stock before you buy. Luna: Sounds good. Where do we start? Lucas: Let's start with Realty Income, ticker O. It's up about 0.8 percent over the last five days, trading around 62 dollars. And it's famous for paying monthly dividends. But a lot of investors look at that yield, which is north of 4.5 percent, and just assume it's safe because the company has this long track record. Luna: And the track record is impressive. They've paid something like 650 consecutive monthly dividends. Lucas: Right, but the mistake is anchoring on that history and not asking what the payout ratio looks like. For a REIT, the payout ratio is usually measured against funds from operations, or FFO, because they have to distribute most of their taxable income. Realty Income's adjusted FFO payout ratio has been hovering around 75 percent. That's manageable, but it's not a huge margin of safety. Luna: So what would make you worry about a REIT like that? Lucas: Well, the bigger risk is in the property portfolio. A lot of their tenants are in retail, and if you see occupancy rates dip or rent collections weaken, that's a red flag before the dividend ever gets cut. The dividend is only as safe as the rent checks coming in. Luna: That makes sense. And I know you wanted to bring up Verizon too, because that yield is even higher, around 6 percent. Lucas: Verizon is up 1.7 percent over the last five days, trading at about 48 dollars. And with that yield, it's tempting to just load up. But the first thing I check is free cash flow. Verizon's free cash flow has been under pressure as they've spent heavily on 5G infrastructure. If free cash flow isn't comfortably covering the dividend, you're relying on debt or cash reserves to pay it. Luna: And that's not sustainable forever. But you've said before that Verizon's dividend is probably safe for now. What's the reasoning? Lucas: Well, they've got a strong balance sheet overall, and their cash flow from operations is still solid. The payout ratio on earnings is around 58 percent, which is below the danger zone. But the market is pricing in some risk, which is why the yield is so high. The question is whether you get paid enough to wait for the free cash flow to recover. Luna: So you'd rather own a stock like that over something like Procter & Gamble, which is down 1.4 percent this week? Lucas: Not necessarily. P&G trades at about 143 dollars, and its yield is only around 2.7 percent. But that dividend has been raised for 68 consecutive years, and the payout ratio is a comfortable 60 percent. Plus, they have pricing power in consumer staples, so their cash flow is more predictable. For a lot of investors, that reliability is worth more than a flashy yield. Luna: Right, and that's the classic growth versus yield trade-off. But with rates as high as they are, you can get a similar yield from a Treasury without the stock risk. Lucas: That's actually the key point, and it's why I think so many investors are making a mistake right now. They see a 6 percent dividend and think it's a no-brainer. But if the ten-year is paying 4.68 percent, you're only getting a little over 130 basis points of extra yield for taking on equity risk. Is that enough? For some people, yes. But you have to be sure the dividend is going to keep coming and ideally grow. Luna: And that's where a lot of people get burned. They didn't do the homework on the payout ratio or the free cash flow. Lucas: Exactly. So here's the checklist I use. First, look at the payout ratio, but make sure you're using the right metric. For most companies, it's earnings per share. For REITs, it's FFO. For oil and gas, it might be free cash flow. Second, check the trend in free cash flow over the last few years. Is it growing, stable, or shrinking? Third, look at the debt levels. A company with a lot of debt and a high payout ratio is risky. And fourth, check the dividend growth history. A consistent history of increases is a good sign, but it's not a guarantee. Luna: That's a solid framework. And it's exactly what we do on this show every week. You know, it's funny, a lot of our listeners tell me they've learned more from these conversations than from any textbook or finance course. And honestly, that's what keeps us going. Lucas: It really is. And if you find these episodes useful, and you want to help us keep the show ad-free, you can support us at buy me a coffee dot com slash fexingo. It's a simple way to say thanks, and it helps us keep doing this. But no pressure, we're just happy to have you listening. Luna: Yeah, it really does make a difference. And speaking of differences, let's get back to that checklist. I want to dig into the free cash flow piece a little more. Lucas: Sure. Free cash flow is basically the cash left over after a company pays for its capital expenditures. That's the money available to pay dividends, buy back stock, or pay down debt. If a company is paying out more than it's generating in free cash flow, they're dipping into the balance sheet. That's not sustainable for long. Luna: And a perfect example of that trap is what happened with that mortgage lender we talked about a few episodes ago. They looked fine on earnings, but the free cash flow was deteriorating. Lucas: Exactly. And that's the thing, earnings can be played with. Cash flow is harder to fake. So when you're evaluating a dividend stock, always look at the cash flow statement, not just the income statement. Luna: So would you say that a company like Realty Income, with its steady FFO, is more attractive than a company like Verizon, where the free cash flow is under pressure? Lucas: It depends on your risk tolerance. Realty Income's yield is lower, but the dividend is very likely to keep growing at a modest pace. Verizon's yield is higher, but there's more uncertainty. For a retiree who needs income now, Verizon might be more appealing. For a younger investor who wants to reinvest dividends, Realty Income might be a better fit. There's no one-size-fits-all answer. Luna: And that's the nuance a lot of people miss. It's not just about the yield. It's about your own time horizon and needs. Lucas: Right. And one more thing to watch is the dividend coverage ratio. That's essentially how many times the company's earnings or cash flow could cover the dividend. A coverage ratio of 2 or more is generally safe. Below 1.5, you should start asking questions. Luna: And what about the payout ratio trend? Is it more important than the level? Lucas: The trend is actually more important than the level. If the payout ratio is rising steadily, it could mean earnings are declining, or the company is being too generous with the dividend. Either way, it's a warning sign. A stable or decreasing payout ratio is healthier. Luna: So what's your take on the market right now? With the S&P 500 at 7,745 and the Dow at 53,460, are dividend stocks a good place to hide out? Lucas: I think they're a good place to be selective. The market is at record highs, but there's a lot of uncertainty around the Fed and the economy. Dividend stocks with strong fundamentals can provide a cushion. But you can't just buy any dividend stock. You have to do the work. And that's what we're trying to help our listeners do. Luna: Well, thanks for breaking it down, Lucas. I think our listeners have a lot to think about. Lucas: And remember, if you're ever unsure about a dividend stock, run it through that checklist. It takes ten minutes, and it could save you from a nasty surprise down the road.