Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Rising Rates Reshape Dividend Portfolios
Transcript
- Lucas: The thirty-year Treasury is sitting just above five-point-one-nine percent as of yesterday. Five-point-two, basically. And that's got me thinking about the end of the 'there is no alternative' era for dividend investors. Luna: Right, because for years the argument was 'buy dividend stocks because bonds pay nothing.' Now bonds actually pay something. So what does that do to the case for a stock like Coca-Cola at two-point-eight percent? Lucas: Exactly. And it's not just Coca-Cola. The ten-year is at four-point-six-seven, up from four-point-six-six, and the two-year at four-point-two. The spread between the ten and two has narrowed to about thirty-nine basis points. So the curve is still positive, but it's flattening. Luna: Flattening, and the thirty-year is at five-point-two. That's a big psychological barrier. Once you can get five percent risk-free, or close to it, a lot of dividend stocks start to look less compelling. Lucas: But I want to push back on that a little. Because it's not just the yield, it's the growth. A bond is a fixed coupon. A dividend stock, especially one with pricing power like Johnson & Johnson or Procter and Gamble, can grow that dividend over time. J&J is yielding around three and a half percent, but they've increased it for over sixty years. Luna: So you're saying the yield at purchase matters less than the total return potential. That's the classic dividend growth argument. But does it hold when the starting yield gap is so thin? Lucas: That's the question. And I think the answer is: it depends on the company. Look at what happened this week. The S&P 500 is up zero-point-eight percent over five days, but dividend-focused ETFs like SCHD and VYM are down. SCHD is off zero-point-nine percent, VYM down zero-point-five. Utilities and REITs got hit harder—Realty Income is down one-point-nine percent. Luna: Because those are the most bond-like equities. When rates rise, their future cash flows get discounted more heavily. So the market is already making the distinction between quality compounders and rate-sensitive income plays. Lucas: Right. And that's the nuance I want to drill into. Because the easy takeaway is 'sell all dividend stocks, buy Treasuries.' But that ignores the fact that some dividend stocks are better positioned than others. Take Coca-Cola. It's down two-point-five percent this week. That's more than the market. But is that a buying opportunity or a warning? Luna: I'd say it's a warning if you're buying it just for the yield. Because the yield is only two-point-eight percent. You're taking equity risk for less than half of what a thirty-year Treasury pays. But if you're buying it for the long-term cash flow growth, then a small pullback might be attractive. Lucas: And that's the key distinction: 'bond substitute' versus 'equity with a growing dividend.' The market is repricing the bond substitutes. Look at Verizon. It's yielding around six and a half percent, and it's barely moved this week, down zero-point-one percent. That's a stock that's already priced for a higher rate environment. Luna: So the market is efficient in that sense. It's not just dumping all dividend stocks; it's punishing the ones that had run up as bond proxies and rewarding those that already offered a big yield cushion. Lucas: Exactly. And I think the bigger picture is the Fed. The September meeting is now a coin flip, with some odds of a hike, especially after the recent comments from the new Fed governor. If they do hike, the ten-year could push toward five percent, and that would put even more pressure on rate-sensitive sectors. Luna: But the Fed funds rate is at three-point-six-three, and it's been flat. So the market is pricing in some chance of a hike, but not a certainty. That uncertainty is what's causing the volatility in dividend stocks. Lucas: Right. And this is where I think the 'if it was worth it' angle comes in. As investors, we have to ask ourselves: is it worth it to hold a dividend stock for the extra yield when I can get a guaranteed five percent from the government? And the honest answer is: for some stocks, no. For others, yes, because the growth potential is real. Luna: So how do we tell the difference? Walk us through that. Lucas: I think the first screen is payout ratio. A payout ratio under fifty percent gives the company room to grow the dividend and invest in the business. J&J's payout is around forty-five percent. Procter and Gamble's is around sixty. That's a bit higher, but still manageable. And then you look at the balance sheet. Companies with a lot of debt are more vulnerable to rate hikes because their interest costs go up. Luna: So you're saying it's not just about the yield; it's about the financial health. And that's something you can't get from a bond. A bond is a bond; you know exactly what you'll get. A stock has variability, but also upside. Lucas: Exactly. And that's why I think the dividend growth strategy is still alive, but it's more nuanced. You can't just buy the highest yield or the most popular dividend aristocrat. You have to do the work. And speaking of doing work, I want to take a quick moment to mention something related to this show. If today's conversation has been worth a coffee to you, the smallest way to keep this podcast ad-free is to support us at buy me a coffee dot com slash fexingo. That's it. No perks, no merch, just knowing you get a cleaner listen. Luna: Yeah, and it genuinely helps us keep the lights on. We appreciate anyone who does that. But back to the topic—you mentioned that you have to do the work. What does that look like in practice for someone listening right now? Lucas: So, let's take a specific example. Realty Income pays monthly, which is great for cash flow. But it's down one-point-nine percent this week. Its yield is now around five-point-three percent. That's close to the thirty-year Treasury. So you're taking on real estate risk for a yield that's not much better. That's a hard sell unless you really believe in the growth of their properties. Luna: Right, and that's a perfect example of a bond substitute getting repriced. But what about a company like Altria, which is up zero-point-three percent this week? It yields around eight percent. That's a different animal. Lucas: Altria is a different risk profile entirely. Eight percent yield suggests the market is pricing in a lot of risk—regulatory, secular decline, whatever. It's not a bond substitute; it's a high-risk income play. And with that yield, you're being compensated for the uncertainty. But you have to be prepared for the possibility of a dividend cut. That's not the kind of stock you buy for stability; it's a stock you buy for yield, and you have to monitor it closely. Luna: So in this rising-rate environment, the spectrum is wide. You have low-risk, low-yield, like Coca-Cola, and high-risk, high-yield, like Altria. And then you have the middle, like J&J, which offers a reasonable yield and a lot of safety. It sounds like the sweet spot might be in the middle. Lucas: I think that's right. And one more thing: look at the dividend growth rate. If a company can grow its dividend at, say, six percent a year, then in five years your yield on cost is meaningfully higher. That's the compounding that a bond can't give you. But you have to be confident in that growth. Luna: And that confidence has to come from the business model, not just the history. A strong brand like Coca-Cola has pricing power. J&J has healthcare that's somewhat recession-resistant. Those are the kinds of businesses that can grow dividends through a rate cycle. Lucas: Right. So my takeaway for this episode is: don't panic and sell all your dividend stocks just because the thirty-year is over five percent. Instead, use this as a moment to reevaluate your portfolio. Ask yourself: which of these companies can grow through a higher for longer rate environment? Those are the keepers. And which ones were just bond proxies? Those might be the ones to trim. Luna: And if you're looking for a quick screen, focus on payout ratio, debt levels, and dividend growth history. That'll get you started. Lucas: I think that's a solid framework. And as always, we're not giving financial advice, just a way to think about it. The next few months will be telling, especially with the Fed decision upcoming. But the principles hold: quality, growth, and a reasonable payout ratio. Thanks for listening, and we'll be back tomorrow.