Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Payout Ratios and Why Low Is Better Than High
Transcript
- Lucas: If you look at Johnson & Johnson today — trading at 253.97, up 5.4 percent in the last five days — and compare it with Verizon at 42.34, down 7.3 percent over the same stretch, the obvious question is: what's protecting one and not the other? Luna: And I bet the answer isn't just 'healthcare versus telecoms.' Lucas: It's not. The real driver is payout ratio. JNJ pays out about 45 percent of its earnings as dividends. Verizon pays out something like 98 percent. That difference is everything in an environment where the ten-year Treasury is yielding 4.38 percent. Luna: So when you're already near the edge, any hiccup — higher rates, slower subscriber growth — hits the stock harder because the dividend itself is at risk. Lucas: Exactly. And we saw that play out with Verizon. When the market started pricing in more rate uncertainty — Cleveland Fed President Hammack even floated the idea that AI could fuel inflation and require more hikes — high-payout stocks get repriced first. Because investors know there's almost no cushion. Luna: Which is why yield alone is a trap. I'd rather own a stock yielding 3 percent with a 40 percent payout ratio than one yielding 6 percent with a 90 percent ratio. Lucas: That's the framework. And it's especially relevant right now because the ten-year is at 4.38, the two-year is at 4.10, and the spread has widened to 30 basis points. A steepening yield curve is historically good for dividend stocks — but only if they're built to last. Luna: Johnson & Johnson has raised its dividend for 63 consecutive years. That kind of track record doesn't happen with a 98 percent payout ratio. Lucas: Right. And JNJ's payout ratio is actually on the higher end of its historical range. They've been around 40 to 50 percent for decades. That gives them room to keep growing the dividend even if earnings dip temporarily. Luna: So what's the threshold? At what point does a payout ratio become dangerous? Lucas: I think the rule of thumb is: below 60 percent for most companies, you're generally safe. Above 80 percent, you're in the danger zone unless you have incredibly stable cash flows — like a regulated utility or a real estate investment trust. But even then, a 90 percent-plus ratio means the company is borrowing or cutting capex just to maintain the dividend. Luna: And that's exactly what happened with Verizon. They've been funding the dividend with debt and asset sales for years. At some point, the market stops giving you credit for it. Lucas: Let's look at another example. Procter & Gamble is down 3.6 percent over the last five days. Their payout ratio is around 60 percent. So even though the stock is falling, it's not falling nearly as hard as Verizon. And P&G is a Dividend Aristocrat — 68 years of increases. Luna: So the payout ratio explains the magnitude of the drawdown, not just whether the dividend is safe. Lucas: Exactly. A low payout ratio acts as a buffer. When rates rise or the economy slows, companies with high payout ratios have to choose between cutting the dividend and hurting the business. Companies with low payout ratios can absorb the shock. Luna: And today, with the ten-year at 4.38, that buffer is even more valuable because investors are comparing dividend yields directly to risk-free rates. Lucas: Right. If a stock yields 5 percent but has a 95 percent payout ratio, the risk-adjusted return is much worse than a stock yielding 3.5 percent with a 40 percent payout ratio. Because you're not just earning yield — you're also betting on dividend growth and capital preservation. Luna: And dividend growth is the real engine of total return over time. A low payout ratio means the company can reinvest more in the business while still raising the dividend. Lucas: Which brings us to the current environment. Small-cap stocks just had their best first half in 35 years. The Russell 2000 is up 1.3 percent over the last five days. That rotation into smaller companies is partly driven by the expectation that the Fed is done hiking — but it also means investors are looking for growth, not just yield. Luna: And if you're in a high-payout stock like Verizon, you miss that rotation entirely because your capital is tied up in a name that's struggling to grow. Lucas: Exactly. So the lesson is: when you're screening for dividend stocks, don't just look at yield. Look at the payout ratio. And compare it to the company's history and its peers. Luna: What about Realty Income? That's a REIT, so the payout ratio is naturally higher because they have to distribute 90 percent of taxable income. Lucas: Right. Realty Income — ticker O — is trading at 61.96, up 0.4 percent over five days. REITs are a different animal. You can't apply the same 60 percent rule because their business model requires high payouts. But even there, you want to look at funds from operations — FFO — and the payout ratio on that basis. O's FFO payout ratio is around 80 percent, which is manageable for a triple-net lease REIT with long-term contracts. Luna: So context matters. The payout ratio is only useful when you understand the industry and the business model. Lucas: Exactly. That's the nuance. But for most industrial, consumer, and healthcare companies — the bread and butter of dividend portfolios — a payout ratio above 80 percent is a red flag. Luna: And we have a real-world example right now: Johnson & Johnson at 45 percent vs. Verizon at 98 percent. One is up, the other is down. Lucas: It's almost a textbook case. And it's why I keep coming back to that metric whenever I look at a new dividend stock. Luna: You know, this kind of analysis is exactly why some listeners have mentioned they appreciate the ad-free format here. It lets us go deep without interruption. Lucas: Yeah, and that's only possible because a small group of listeners chips in monthly through buy me a coffee dot com slash fexingo. It's not a big ask — just a way to keep the show independent and focused on what matters. Luna: And it means we don't have to chase clicks or sponsored segues. We can just talk about payout ratios and yield curves for ten minutes. Lucas: Exactly. And speaking of yield curves — the fact that the ten-year is at 4.38 and the two-year at 4.10 means the curve is steepening. That's historically bullish for dividend stocks that can grow their payouts. Luna: Because a steep curve usually means the economy is expected to grow, which supports earnings and dividend increases. Lucas: Right. But only for companies with the financial flexibility to raise the dividend. And that flexibility comes back to the payout ratio. Luna: So if you're building a portfolio today, you'd want to overweight stocks with payout ratios under 60 percent, especially in a steepening curve environment. Lucas: That's the playbook. And it's why Johnson & Johnson, despite being a huge cap, still has room to run. They have the balance sheet, the payout ratio, and the dividend growth history. Luna: What about Coca-Cola? KO is at 81.27, up 0.8 percent. Their payout ratio is around 75 percent — higher than JNJ, but still manageable. Lucas: Coca-Cola is a good example of a stock where the payout ratio is a bit higher, but it's justified by incredibly stable cash flows. They've been paying a dividend since 1920 and increasing it for 63 years. So 75 percent is fine for them. But if that number ever crept above 90 percent, I'd start paying attention. Luna: So the threshold isn't a hard line, but a warning signal. Lucas: Exactly. And the warning is especially loud when rates are at 4.38 percent because the opportunity cost of owning a risky dividend stock is higher. Luna: Alright, so final takeaway: before you buy any dividend stock, check the payout ratio. If it's above 80 percent, ask why. If there's no good answer, move on. Lucas: And if it's below 60 percent, you're probably in good shape — especially if the company has a history of raising the dividend through different rate environments. Luna: That's the kind of concrete rule that actually helps you sleep at night. Lucas: It does. And it's the difference between owning Verizon and owning Johnson & Johnson. Same market, very different outcome.