Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Dividend Stocks Stumble as Treasury Yields Surge
Transcript
- Lucas: So we're about a week into the new Fed chair's tenure, and bond yields are already making dividend investors uncomfortable. The 10-year Treasury just touched 4.49 percent, up about 6 basis points in a matter of days. Luna: And you can see the reaction in dividend stocks. SCHD, the Schwab U.S. Dividend Equity ETF, is down almost 3 percent in five days. JNJ off more than 5 percent. VZ down nearly 6 percent. Lucas: Right, and that's the paradox we've talked about before — when risk-free rates go up, the income premium that dividend stocks offer starts to look less compelling. At 4.49 percent on a 10-year Treasury, you can get a pretty decent nominal return without taking any equity risk. Luna: So the question is whether this sell-off is an overreaction or the start of a real rotation away from dividend payers. Let's look at a few names and see what the data says. Lucas: Good idea. Let's start with Verizon. It yields over 5 percent right now — around 5.3 percent based on the current price. On the surface, that's still well above the 10-year. But the stock is down 5.7 percent in five days. That tells me the market is pricing in more than just yield competition. Luna: More like concern about the dividend's sustainability. Verizon's payout ratio based on earnings is over 80 percent. Its free cash flow coverage is thin. When rates rise, leverage costs go up, and a company with heavy debt — Verizon has about $150 billion — feels the squeeze. Lucas: Exactly. Compare that to a stock like Coca-Cola. KO is down 3.3 percent in the same period, so it's not immune, but its payout ratio is around 75 percent and its free cash flow is enormous. It has pricing power, global diversification, and a much stronger balance sheet. The dividend is safer. Luna: Which is why the market is punishing Verizon more harshly. It's not just about yield — it's about the quality of that yield. And that's where I think the real lesson is for dividend investors right now. Lucas: Let's drill into that. In a rising rate environment, the cost of debt goes up for everyone, but it hits highly leveraged companies hardest. If a company's free cash flow barely covers the dividend when rates are low, a 100-basis-point increase in borrowing costs could force a cut. That's exactly the scenario the market is pricing into Verizon. Luna: And Altria — MO — down 2.5 percent in five days. Its yield is over 8 percent, but the payout ratio is well over 100 percent based on earnings. They've been funding the dividend with debt and cost cuts. That's not sustainable. Lucas: So the market is effectively saying: 'I'd rather have a 4.5 percent risk-free yield than an 8 percent yield that might get cut.' And that's rational. The question is, where does that leave investors who need income? Luna: I think it forces a shift toward quality. Companies with lower payout ratios, strong free cash flow, and manageable debt. Think about stocks like Microsoft or Apple — they pay dividends but the yields are low, around 1 percent. They're not in this conversation. But for yield-oriented portfolios, you might look at utilities with regulated revenue, or consumer staples with pricing power. Lucas: Utilities are interesting because they have high debt loads but also regulated returns. The yield on the average utility is around 3.5 percent, but the stocks have been relatively stable. The market seems to be giving them a pass because the earnings visibility is higher. Luna: And then there's the broader market context. The S&P 500 is essentially flat over the past five days. The Dow is near all-time highs. So this dividend sell-off is specific, not a broad market panic. It's a repricing of risk within the income space. Lucas: Which brings us back to the Fed. Kevin Warsh has signaled a more hawkish stance than many expected. The market is now pricing in a higher terminal rate. That directly affects the discount rate used to value dividend stocks — higher rates mean lower present values for future dividends. Luna: So it's a double whammy: higher risk-free rates make dividends less attractive, and higher discount rates lower the intrinsic value of the stocks. No wonder we're seeing this rotation. Lucas: But here's the thing — for long-term dividend investors, this could be an opportunity. When quality dividend stocks sell off because of macro factors, not company-specific problems, you can lock in higher yields at lower prices. The key is distinguishing between a temporary yield spike and a structural dividend risk. Luna: And that's where the homework comes in. Look at free cash flow yield relative to the dividend. Look at debt maturities and interest coverage. If a company can easily service its debt even at higher rates, the dividend is probably safe. Lucas: Right. And if you think about it, these kinds of episodes are exactly why we do this show — to help people think through the noise and make informed decisions. It's not about predicting the next move, but about having a framework. Luna: Speaking of which, we get a lot of messages from listeners saying these conversations have genuinely helped them avoid mistakes or feel more confident. That's the whole point. Lucas: Yeah, and if you're one of those listeners, and you've gotten value out of what we do here, there's a simple way to support the show. A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo. It helps us stay ad-free and focused on the substance. Luna: Absolutely. No pressure, but if it's made a difference in your investing journey, it's worth considering. And now back to the numbers. Lucas: So let's look at a specific example of a stock that might be worth buying on this dip. Johnson & Johnson — down 5.2 percent in five days. The yield is now about 3.4 percent. The payout ratio based on adjusted earnings is around 45 percent. Free cash flow covers the dividend comfortably. And the balance sheet is strong — AA credit rating. Luna: JNJ also has a diversified revenue stream — pharmaceuticals, medical devices, consumer health. That's a moat. And they've increased the dividend for 60-plus years. This sell-off looks more like macro noise than a fundamental problem. Lucas: Exactly. Compare that to a name like 3M, which has been cutting dividends in recent years. The market treats them very differently. So the lesson is: don't buy the yield, buy the stability. Luna: Another one to watch is Realty Income, ticker O. Down 4 percent in five days. It's a triple-net lease REIT, so the income is tied to long-term leases. The yield is now around 5.7 percent. But REITs are more sensitive to rates because they borrow a lot. O's debt is mostly fixed-rate, so the near-term impact is limited, but the market is selling first and asking questions later. Lucas: That's the theme this week — indiscriminate selling. The market is punishing all dividend stocks, but the good ones will recover faster. The bad ones might not. So the work for investors is to separate the two. Luna: And that work includes looking at the yield curve. The 10-year minus 2-year spread is about 27 basis points — still inverted, but less so than before. A steeper curve is usually good for banks, but for dividend stocks, it means higher long-term rates persist. Lucas: Right, and the 30-year is at 4.93 percent. That's getting close to 5 percent, which is a psychological threshold. If the 30-year breaks above 5 percent, I think we'll see another leg down in rate-sensitive dividend names. Luna: So what's your takeaway for someone listening right now? Should they be buying, holding, or selling? Lucas: I'd say hold the quality names, consider adding to positions in stocks like JNJ or KO if you have a long time horizon, and be very cautious with high-yield names that have weak fundamentals. This is not the time to reach for yield. Luna: And if you're in a dividend ETF like SCHD, it's down 3 percent but the holdings are mostly quality companies. The ETF will likely recover as long as the underlying companies stay healthy. So don't panic. Lucas: Exactly. The dividend investing playbook hasn't changed — it's just being tested. Higher rates test the quality of the income. And that's actually a healthy thing for markets in the long run. Luna: Alright, next episode we'll look at a specific sector that might benefit from this rotation — maybe financials, since banks tend to do well when the curve steepens. Lucas: Good idea. Until then, keep your dividend analysis fundamental and your emotions in check.