Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why Dividend Growth Beats High Yield in a Steep Curve
Transcript
- Lucas: So the ten-year Treasury is sitting at 4.40 percent as of last Friday, and the yield curve is steep — the spread between the two-year and the ten-year is about 31 basis points. Normally that environment crushes high-dividend stocks, because why take equity risk for a yield that bonds can match? But look at what's actually happening. Realty Income, ticker O, is up four point two percent in the last five days. Coca-Cola, KO, up three point nine. Altria up over six percent. These are classic high-yield names, and they're rallying. Luna: So the old playbook — 'sell dividends when bonds yield more' — is not working this time. Why? Lucas: I think the market is pricing in that rates have peaked. The Fed Funds rate has been flat at three point six three percent since May. Minneapolis Fed President Kashkari said he still expects a hike this year, but the bond market isn't buying it. The two-year yield actually dropped a couple of basis points last week. So the steep curve is less about rising long-term rates and more about the front end coming down. That's actually good for dividend stocks — it reduces the competitive pressure from short-term bonds. Luna: But Realty Income yielding around five point five percent still looks attractive relative to a ten-year at four point four. That's over a hundred basis points of spread. Lucas: Exactly. And that spread is why we're seeing capital flow into REITs. O is up four point two percent in five days, DVY — the iShares Select Dividend ETF — is up two point six. But here's the twist I want to drill into today. The real outperformance over the long term isn't coming from the highest current yield. It's coming from dividend growers. Companies that raise their payout every year, even if the starting yield is lower. And in a steep curve, that growth compound matters more. Luna: You're talking about the Dividend Aristocrats — companies that have increased dividends for at least 25 consecutive years. Lucas: Right. And we have a perfect example in the data. Johnson & Johnson, JNJ, is up over ten percent in the last five days. That's not a high-yield play — its yield is around three point two percent. But it just raised its dividend for the sixty-third consecutive year. The market is rewarding that consistency. Procter & Gamble, up less than one percent, but it's a grower too. Coca-Cola up almost four percent — it's a grower, not a high-yielder per se. The message is: in a steep curve where the long end is sticky, investors are willing to pay up for predictable real income growth. Luna: And that's the counterintuitive piece. A lot of listeners might think, well, if I want income, I should just buy the highest yield I can find. But total return over time — dividends plus price appreciation — favors the growers. Lucas: There's a famous study from Hartford Funds that looked at the period from 1973 to 2023. Dividend growers outperformed non-dividend payers by an average of two point three percent per year. And they also had lower volatility. The reason is simple: a company that consistently raises its dividend is signaling that its earnings are growing and its cash flow is durable. That attracts long-term capital. High yield without growth often means the dividend is at risk. Luna: And that's exactly what we saw with some of the high-yield REITs in 2023 and 2024 — they cut when rates spiked. Realty Income was an exception because of its triple-net lease model and its track record. Lucas: O has raised its dividend for over 25 years, so it's actually an Aristocrat. But even among Aristocrats, the growth rate matters. JNJ's dividend growth rate over the last five years has been about five point six percent annually. KO's is around four point five. PG's is about four percent. Those might not sound huge, but when you compound over a decade, the income doubles. A high-yield stock with no growth — your income stays flat in nominal terms, and inflation eats it. Luna: So for someone building a portfolio today, with the ten-year at four point four, what's the right mix? Do you go heavy on growers or do you take some of that high yield while it's available? Lucas: I'd lean into growers as the core, but I wouldn't ignore yield entirely. The key is to look at payout ratio. If a high-yield stock has a payout ratio under 60 percent, the dividend is probably sustainable. O's payout ratio is around 85 percent, but that's normal for a REIT — they have to distribute most of their income. For a non reit, anything above 80 percent is a red flag. Altria, for example, has a payout ratio over 80 percent, and its yield is over eight percent. That's a risk. The market might be pricing in a cut eventually. Luna: But Altria is up six percent this week. So the market isn't pricing in a cut right now. Lucas: No, but that's short-term momentum. The data we have — the steep curve, the flat Fed Funds rate — suggests a 'risk-on' mood for income. Investors are reaching for yield. But if the economy softens, those high-payout names get hit first. Growers like JNJ and KO have pricing power and defensive earnings. They hold up better in a downturn. And we saw that in 2022 — when the S&P dropped 19 percent, the Aristocrats index fell only about 10 percent. Luna: So the takeaway for listeners might be: don't chase the highest yield blindly. Look for companies with a long history of dividend increases and a payout ratio that leaves room for growth. Lucas: And if you have gotten something out of these conversations, you know that we keep the show independent and ad-free because of listener support. A couple of bucks a month at buy me a coffee dot com slash fexingo genuinely makes a difference. It's what keeps us digging into these questions rather than reading ad copy. Luna: Yeah, it's a small thing that adds up. And we appreciate everyone who chips in. Lucas: So back to the steep curve. The other factor is that dividend growers also tend to have lower beta — they're less sensitive to market swings. In a world where the S&P 500 is down one point six percent over the last five days, but the Dow is up, that tells you the rotation is toward quality. Growth stocks are getting sold, but steady earners are being bought. That's the environment where dividend growers shine. Luna: And that's been the narrative all year — from the AI frenzy to this rotation into defensives. The NASDAQ is down over three percent in five days. So money is flowing out of tech and into dividends. Lucas: Exactly. And the steep yield curve reinforces that. When the two-year yield falls relative to the ten-year, it usually signals that the market expects the Fed to cut. That's bullish for equities broadly, but especially for rate-sensitive sectors like utilities and consumer staples. Both are heavy in dividend growers. So we're in a sweet spot where the macro backdrop supports both high yield and dividend growth. But if I had to choose one, I'd pick the growers for the long haul. Luna: Let's make it concrete. If someone has ten thousand dollars to put into dividend stocks today, what's one ETF and one individual stock that capture this thesis? Lucas: For the ETF, I'd point to SCHD — the Schwab U.S. Dividend Equity ETF. It's up one point four percent in five days. It focuses on companies with sustainable dividends and growth, not just the highest yield. Its top holdings include Coca-Cola, PepsiCo, and Broadcom — a mix of growers and some higher yield. For an individual stock, I'd go with JNJ. It's up ten percent this week, but it still yields over three percent and has that 63-year streak. The payout ratio is around 45 percent, so there's plenty of room to keep raising. Luna: And JNJ just got a boost from the stress test results — the Fed cleared it for dividend increases. Lucas: That helped. But the underlying driver is the business. JNJ has a diversified healthcare model — pharmaceuticals, medical devices, consumer health. That gives it pricing power and resilience. Even if the economy slows, people still need healthcare. So the dividend growth is on solid ground. That's the kind of stock that works in a steep curve, a flat curve, or even an inverted curve. Luna: So the one concrete thing listeners can take away: check the dividend growth rate and payout ratio before you buy. Don't just look at yield. Lucas: Exactly. And with the ten-year at four point four, the bar for dividend stocks is higher. But the growers are clearing it.