Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / The Case for Dividend Growth Stocks in a Rate-Cut Cycle
Transcript
- Lucas: So the S&P 500 is at 7,431 today, but if you look under the hood, the action isn't in mega-cap tech. Apple and Microsoft are both down sharply over the past week — Apple off 3.5 percent, Microsoft off more than 5 percent. Luna: Meanwhile, the Russell 2000 is up over 3 percent in the same period. Small caps waking up. Lucas: Exactly. And value-oriented dividend payers are standing out. Bank of America up 4.5 percent in five days. JPMorgan up 3.1 percent. These aren't just bounce plays — they are starting to attract a different kind of flow. Luna: The dividend growth trade. We touched on it briefly a few episodes ago, but I want to go deeper today. Because in a rate-cut cycle, the math on dividend compounding changes. Lucas: It really does. Let's frame it simply: if you own a stock yielding 2.5 percent that grows its dividend at 10 percent per year, over a decade you are earning a yield on your original cost that is well above 5 percent. Meanwhile, a 5 percent bond doesn't grow. Its coupon is fixed. Luna: And with the Fed likely cutting rates again later this year or early 2027, bond yields will come down, making that growing dividend stream even more attractive on a relative basis. Lucas: Right. So the question is: which dividend growers actually have the financial strength to keep raising payouts through a slower economy? Not every company with a high yield is safe. Some are dividend traps. Luna: So what is your screen? How do you separate the growers from the traps? Lucas: I look at three things. First: payout ratio below 60 percent. If a company is paying out more than 60 percent of earnings as dividends, there is not much room to raise the payout if earnings dip. Second: free cash flow yield above the dividend yield. That means the company is generating more cash than it is paying out, giving it a buffer. And third: positive free cash flow growth over the last three years. Luna: So you want companies that are earning their dividend, not just borrowing to pay it. Lucas: Exactly. And I think that is why financials like Bank of America and JPMorgan are passing the screen right now. Both have payout ratios in the low 30s. Their free cash flow yields comfortably exceed their dividend yields. And they have been raising dividends consistently for years. Luna: But there is a risk: if the economy slows sharply, loan losses rise, and earnings drop. Then the payout ratio spikes even if the dividend stays flat. Lucas: That is a real risk. But the counterargument is that these banks have built substantial capital buffers since the 2008 crisis. Their loan loss provisions are manageable, and their net interest margins are still benefiting from the higher rate environment that prevailed through 2024 and 2025. Even as rates ease, the margin compression is gradual. Luna: Fair. Let's take another one: energy. ExxonMobil and Chevron have been notable dividend payers, but both are down this week — Exxon off 3.1 percent, Chevron down 1.1 percent. Oil prices are soft. Lucas: That is the cyclical trap. When oil drops, their free cash flow shrinks. Their payout ratios rise. They can still afford the dividend in most scenarios because they have low breakeven costs, but the growth trajectory becomes uncertain. I would rather own a company with a lower yield but a more predictable earnings stream. Luna: Speaking of predictable streams — what about Pfizer? It is up 2.3 percent this week. Yield is attractive, but growth has been a question. Lucas: Pfizer is a turnaround story, not a dividend growth compounder in my view. They cut their dividend after the COVID revenue cliff. They are rebuilding. But the payout ratio is still above 70 percent, and free cash flow has been negative in some quarters. So it fails my screen. That does not mean it is a bad stock — just not a reliable dividend grower right now. Luna: So who passes your screen? Besides the banks, any names you are watching? Lucas: I think the broader market is starting to reward companies with strong free cash flow and low payout ratios. Some industrial names, select consumer staples, and even a few technology companies that have started paying dividends. Microsoft yields less than 1 percent, but it has raised its dividend for over 20 consecutive years. For a tech giant with massive cash flows, that is a meaningful signal. Luna: And if the Russell 2000 continues its run, we might see more small-cap companies initiating or growing dividends as they mature. Lucas: That would be a healthy sign for the market. A broadening rally where more companies participate and return capital to shareholders — that is the kind of environment where dividend growth strategies can really compound. Luna: We've been talking about how to build portfolios that generate income without taking on excessive risk. That is exactly the kind of conversation we try to have on this show every day. Lucas: And we keep it ad-free because we believe financial education should be accessible, not interrupted by pitches. If you find value in that approach and want to support it, you can do so at buy me a coffee dot com slash fexingo. Luna: It is a simple way to keep the show independent. No pressure, but every contribution helps us spend more time on research like this. Lucas: Back to the screen: one thing I want to emphasize is the power of reinvesting dividends. A stock with a 3 percent yield and 8 percent dividend growth, if you reinvest those dividends over 15 years, your yield on cost can exceed 10 percent. That is the compounding engine. Luna: And in a rate-cut cycle, that stream becomes more valuable as bond yields fall. So the case for dividend growth stocks is not just about income — it is about total return. Lucas: Exactly. And the current market setup — with value outperforming, small caps rallying, and large-cap growth under pressure — is exactly the kind of rotation that historically rewards dividend growth investors. Luna: Alright, so let's build a quick watchlist. Bank of America, JPMorgan, Microsoft — three stocks with different yields but all with consistent dividend growth and strong free cash flow. Lucas: And I would add a couple of mid-cap names that pass the screen. I will share them in a future episode after I dig into their filings. But the framework is what matters: payout ratio below 60 percent, free cash flow yield above dividend yield, and positive free cash flow growth over three years. Run that screen and you will find a handful of high-quality growers. Luna: That is actionable. Thanks, Lucas. Lucas: Always a pleasure.