Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / The Dividend Growth Rate That Matters Most
Transcript
- Lucas: I was looking at the daily reports for Verizon today, and the stock is up nearly six percent over the last five days. The yield is sitting right around seven percent, which looks incredible on paper if you are just scanning for cash flow. But if you actually dig into the dividend history, the growth rate has been stuck in single digits for years, barely keeping pace with consumer price index readings. Luna: So you are saying that a seven percent yield feels good until you realize your purchasing power is slowly being eaten away by inflation because the payout isn't growing? That is the classic trap of chasing current income instead of future cash flow. Lucas: Exactly. And it gets worse when you compare that to a company like Procter and Gamble. Their yield is less than three percent, yet they have raised their dividend every single quarter for decades. The compound annual growth rate on their payouts is consistently higher than what you get from most high-yield utility stocks or telecoms. Luna: Right, because the total return matters more than the initial check size. If I buy something yielding two percent that grows at eight percent a year, I will eventually overtake the person who bought something yielding seven percent that stays flat. Lucas: That math is simple, but it fights against our natural instinct. We see a big number now and we think we are winning. In November two thousand twenty six, with the ten-year Treasury yield at four point nine five percent, the bar for quality is much higher. You need a business that can actually justify raising that payout every year without sacrificing its balance sheet. Luna: It makes me wonder how many of these legacy dividend kings are actually just slow growers that got lucky with low interest rates for the last fifteen years. Are we seeing a lot of strain in their ability to keep those raises going? Lucas: We are seeing a divergence. Companies with pricing power are fine. Look at Johnson and Johnson. Even though the stock has been quiet, their healthcare business generates massive free cash flow that supports steady dividend growth. They are not trying to be flashy; they are just printing money from established products. Luna: But what about the REITs? People love Realty Income for that monthly check, but their cap rates are getting squeezed by the long end of the curve. Is that model still viable if borrowing costs stay elevated? Lucas: It is viable only if you are picking the right properties. Realty Income is focused on net leased commercial real estate, which is different from an apartment complex. But the broader lesson is that debt hurts everyone. When the Fed Funds effective rate is sitting at three point eight eight percent, any company with heavy leverage feels the pinch. Luna: So the focus should really be on companies that don't need to borrow money to grow their dividends. Self-funding seems like the ultimate moat right now. Lucas: Self-funding is the key. When you look at the S&P 500, the aggregate earnings per share growth is solid, but dividend growth lags behind it significantly. That gap tells you a lot about management's confidence. If they are paying out all their cash, they are either very mature or they have no ideas for reinvestment. Luna: Which sounds like a red flag. If a company has no new ideas, isn't that exactly where value traps hide? They pay you to wait for the decline. Lucas: Precisely. And that brings us to the data point that really stands out today. The Russell 2000 small cap index is down slightly, but the Dow Jones Industrial Average is up almost two percent. Large caps with strong balance sheets are leading the charge because they have the liquidity to navigate this rate environment. Luna: I guess that explains why the quality ETFs are holding up so well while the speculative tech names are wobbling. Investors are rotating back to boring, profitable businesses that can actually pay the bills. Lucas: It is a rotation toward certainty. When the VIX is calm but yields are creeping up, people stop gambling on future promises and start demanding current cash flow. But as I said, it has to be growing cash flow. A static dividend is a dying dividend in real terms. Luna: So how do you actually screen for that? Do you just look at the last five years of payout increases, or is there a deeper metric you use to filter out the fakers? Lucas: You look at the payout ratio relative to free cash flow, not just accounting earnings. Earnings can be manipulated with depreciation schedules and one-time charges. Free cash flow is the actual cash left over after keeping the lights on. If a company is paying out ninety percent of its free cash flow, they have zero room for error. Luna: That makes sense. It is like checking your personal budget. If you spend every dollar you earn, you cannot afford to increase your savings rate next year, no matter how much you make this month. Lucas: Spot on. And that is why I prefer looking at companies with a payout ratio under sixty percent of free cash flow. It gives them a buffer. If sales drop ten percent next year, they can still maintain the dividend and maybe even raise it slightly. Luna: That buffer is what separates the serious income builders from the yield chasers. You are building a machine that compounds, not just a bucket that holds cash. Lucas: Exactly. And let me ask you this: if you had to choose between a stock that pays five percent today and grows two percent a year, versus one that pays three percent today and grows ten percent a year, which one would you pick for a twenty year horizon? Luna: There is no contest. The second one ends up paying way more in the long run. The first one leaves you with a shrinking percentage of your portfolio coming from dividends as time goes on. Lucas: Right. So why do we get seduced by the front-end load? It is human nature to want the big check now. But in finance, patience always wins if the underlying asset is healthy. Luna: It is definitely harder to watch a lower yield grow slowly than to see a high yield sit there doing nothing. But the compounding effect is undeniable once you do the math. Lucas: Let me put a number on it. If you invest ten thousand dollars in a stock yielding three percent with ten percent annual dividend growth, in twenty years your annual dividend income will be roughly fifty-eight hundred dollars. That is nearly six percent of your original principal, just from the growth. Luna: Wow. Versus the five percent yield that never grows, you would only have five hundred dollars a year in extra income. That is a fifty-three hundred dollar difference purely from the growth rate. Lucas: And that doesn't even count the capital appreciation that usually comes with a growing business. You are getting paid twice. Once through the rising checks, and again because the market re-rates the stock higher as earnings expand. Luna: So the real strategy is finding those rare companies that can sustain that double-digit growth for a decade or more. That is where the alpha lives. Lucas: It is hard work. You have to read the filings and understand the business model. You can't just download a spreadsheet and sort by yield. But that effort filters out the noise. Luna: Yeah, and it keeps you awake at night knowing that your income is actually increasing, not eroding. That peace of mind is worth more than a few extra basis points of current yield. Lucas: Absolutely. And speaking of support, if these conversations help you rethink your own portfolio allocation... Luna: Honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. Lucas: It keeps the research ad-free and allows us to keep digging into these numbers. Thanks for helping us keep the lights on. Luna: Back to the charts, because there is one more thing about that Procter and Gamble example that really sticks out. Lucas: What is it? Their brand loyalty? Luna: No, it is their pricing power. They raise prices on toothpaste and detergent, and people just keep buying it. That is the engine that funds the dividend growth. Lucas: Right. Pricing power is the ultimate inflation hedge. If you own a business that can raise prices without losing customers, your dividend growth is guaranteed. Luna: So the next time you look at a yield, ask yourself: can they actually raise it next year? If the answer is no, walk away. Lucas: Good rule of thumb. Because in this market, stability is not about standing still. It is about moving forward, steadily, every single year.