Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why Dividend Stocks Outperform When Bonds Yield 4.48 Percent
Transcript
- Lucas: So the ten-year Treasury hit 4.48 percent on July first — up from 4.44 just a week earlier — and you'd think that would suck the air out of dividend stocks, right? Instead, Johnson & Johnson is up 3.3 percent over the past five days, Coca-Cola up 1.8 percent, Procter & Gamble up 1.6 percent. Luna: It's the exact opposite of the conventional wisdom. Higher risk-free rates are supposed to make dividend yields look stingy. Lucas: Exactly. And look, this is the kind of conversation where I have to be honest: our show stays ad-free 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 mentioning it because what we're about to dig into takes time to research, and that support makes it possible. Luna: Yeah, and it keeps us independent, so we can talk about yield spreads and payout ratios without any sponsor pressure. Lucas: Right. So let's get into the numbers. The ten-year is yielding 4.48, but JNJ's dividend yield today is about 3.1 percent — on the surface, bonds win. But the market is pricing in something else. Luna: Dividend growth. JNJ has raised its payout for 63 consecutive years. That 3.1 percent yield today compounds if you hold. Lucas: Exactly. A bond coupon is fixed — you get your 4.48 percent until maturity, and then you have to reinvest at whatever rate exists then. With a dividend grower, your yield on cost increases every year. JNJ's five-year dividend CAGR is about 5.6 percent. So if you bought JNJ a year ago around $240, your yield on cost is already higher than the current ten-year. Luna: That's the math that drives the trade. And it's not just JNJ. Coca-Cola has raised its dividend for 62 years. The ten-year yield spiked, but KO is up 1.8 percent this week. Lucas: Let's zoom out. The yield curve spread — ten-year minus two-year — widened to 35 basis points on July second, up from 31. That's still a positively sloped curve, which historically favors dividend growers over high-yield plays. Luna: Because in a steep curve, the market expects economic growth, and growth supports dividend increases. Meanwhile, the highest-yielding stocks — utilities, REITs, telecoms — tend to get crushed. Lucas: Verizon is down 8.6 percent this week. Its yield is over 6 percent now, but the market is saying that yield might not be sustainable. The payout ratio is around 55 percent, but the business is shrinking — revenue down year-over-year, debt load high. Luna: So the market is rewarding dividend quality, not just yield. JNJ and KO have rock-solid payout ratios in the 40 to 60 percent range, with free cash flow coverage. Lucas: Right. The S&P 500 is up 1.8 percent this week, the Dow up 2 percent. Dividend aristocrats are actually outperforming the broad market. The VYM ETF — Vanguard High Dividend Yield — is up 0.8 percent, but SCHD, which screens for dividend growth and quality, is up 0.9 percent. Luna: Small cap is the laggard. The Russell 2000 is down 0.5 percent. So the rotation is into large-cap quality with dividend growth potential. Lucas: And that's the paradox of the 4.48 percent ten-year. If you believe rates will stay elevated, the argument for bonds gets stronger. But if you think rates will eventually come down — and the Fed funds rate is still at 3.63 percent, flat since June — then locking in bond yields today might look short-sighted. Luna: Because when rates fall, bond prices rise, but your coupon stays the same. Dividend stocks, on the other hand, can raise their payouts even in a falling rate environment. Lucas: Let's put a concrete number on it. If you put $100,000 into the ten-year Treasury at 4.48 percent, you get $4,480 per year in interest, fixed for ten years. If you put that same $100,000 into JNJ at today's price, you get about $3,100 in dividends the first year. But if JNJ raises its dividend by 5 percent annually, by year five you're getting about $3,950, and by year ten about $5,050. Luna: So after ten years, the dividend stream overtakes the bond coupon, and you still own the stock, which may have appreciated. Lucas: That's the total return case. And the market is betting on that scenario. The ten-year yield jumped 4 basis points this week, but JNJ and KO went up. The market is saying: we trust these companies to grow through the cycle. Luna: But there's a risk. If the economy slows and earnings fall, dividend growth could stall. Then you're stuck with a yield that's below the risk-free rate. Lucas: That's the key qualifier. Dividend growth is not guaranteed. That's why you look at payout ratios, free cash flow, and debt levels. JNJ's payout ratio is about 45 percent of earnings, and its free cash flow covers the dividend 1.5 times. That's a wide moat. Luna: Altria, on the other hand — MO — is down 1.5 percent this week. Its yield is over 8 percent, but the payout ratio is over 80 percent, and volumes are declining year after year. Lucas: So the market is punishing high payout ratios in a rising yield environment. The 30-year Treasury is at 4.97 percent — almost 5 percent. If you can get nearly 5 percent risk-free, why take equity risk for an 8 percent yield that might be cut? Luna: That's the distinction. Dividend growth stocks are competing on total return potential. High yield stocks are competing on income alone, and they're losing. Lucas: And the data backs it up. The VYM ETF, which holds higher-yielding stocks, is up 0.8 percent this week. SCHD, which emphasizes dividend growth and quality, is up 0.9 percent. DVY, the iShares Select Dividend ETF, is up 0.6 percent. The growth-quality tilt is winning. Luna: So what's the play for listeners? If they're building a dividend portfolio today with the ten-year at 4.48 percent, what should they focus on? Lucas: I'd say focus on dividend growth rate and payout ratio sustainability. Companies with a five-year dividend CAGR above 5 percent and a payout ratio below 60 percent. That gives you a buffer. Also, look at free cash flow yield — companies that generate cash well in excess of their dividend. Luna: And avoid sectors with structural decline. Telecom, tobacco, some utilities. The market is already voting with its feet. Lucas: Exactly. And one more thing: the yield curve is steepening. The ten-year minus two-year spread is now 35 basis points, up from 31. Historically, a steepening curve favors dividend growers over high yield. So the market is aligning with the fundamental thesis. Luna: It's a time to be picky. Not all dividends are created equal. Lucas: Right. And that's the takeaway. The ten-year at 4.48 percent isn't the enemy of dividend investing — it's the filter. It separates the companies that can grow their payouts from the ones that are just offering a high coupon. Luna: And in a world where the Fed is on hold at 3.63 percent, that filter is going to stay relevant. Lucas: Exactly. So as always, know what you own, and why you own it. For us, that's the conversation. We'll be back soon.