Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / How the S&P 500 Dividend Yield Hit a 25-Year Low
Transcript
- Lucas: So the S&P 500's dividend yield closed yesterday at 1.2 percent. That's the lowest in 25 years. And I think that single number tells you a huge amount about what's going on underneath the hood of this market. Luna: 1.2 percent — that's basically nothing. The ten-year Treasury is at 4.5 right now. Why would anyone own stocks for income at that spread? Lucas: Exactly. And that's the tension. The equity risk premium has basically inverted for income. But the story isn't just about rates — it's about what companies are doing with their cash. Buybacks are at record levels, and the biggest index weights — the mega-cap tech names — simply don't pay much of a dividend. Luna: Let's talk about that composition shift, because Apple, Microsoft, Alphabet, Amazon, Meta, NVIDIA — they're about 28 percent of the S&P 500 by weight, and their average dividend yield is what, maybe 0.4 percent? Lucas: Roughly. Apple yields about 0.5, Microsoft 0.7, and the rest basically nothing. Amazon and Alphabet still don't pay a dividend. So as those stocks have grown to dominate the index, the aggregate yield gets dragged down mechanically, even if old-economy dividend payers keep their payouts steady. Luna: Right. But it's not just the weight effect. Even among companies that do pay dividends, the payout ratio — the percentage of earnings paid out — has been shrinking. I think it's around 35 percent now versus a historical average closer to 50. Lucas: That's the second layer. Companies are retaining more earnings, partly to reinvest in AI and capex, and partly because buybacks are more tax-efficient for many shareholders. But there's a third factor, too: stock-based compensation. When companies issue shares to employees, that dilutes existing holders. To offset that dilution, they often buy back stock, which consumes cash that might otherwise go to dividends. Luna: So the narrative that 'buybacks are just an alternative to dividends' holds — but it's not the whole story. The question is whether this trend is permanent or cyclical. Lucas: I think it's partly structural. The rise of index investing and the focus on total return — capital appreciation plus dividends — has made dividends less central. Many fund managers now say, 'Just return cash via buybacks; we'll generate our own yield by selling shares.' And for growth investors, that makes sense. But for income-focused investors — retirees, endowments, pension funds — it's a real problem. Luna: Yeah. And that's where the value stock versus growth stock divide gets sharp. The S&P 500 Value index — think the IWD ETF — yields about 2.2 percent. Still below the ten-year, but a lot better than the growth side. Lucas: Which brings us to a specific example. JPMorgan Chase — ticker JPM — yields about 2.3 percent right now, and it's actually up 4 percent over the past five days. Banks have been beneficiaries of higher rates, and they've been increasing dividends. JPM raised its dividend by 9 percent earlier this year. So there are pockets of yield out there. Luna: But even within value, the dividend growth has slowed. The average dividend growth rate for S&P 500 companies in Q1 this year was something like 5 percent, down from 8 percent a year ago. So it's not just the yield level — the growth is slowing too. Lucas: And that's partly because earnings growth is moderating. On a trailing twelve-month basis, S&P 500 earnings per share are up about 6 percent year-over-year. But a lot of that has been absorbed by buybacks and capex, not dividend increases. The payout ratio has fallen about 300 basis points over the past two years. Luna: So for a stock picker focused on income, what's the play? Do you go further down the market-cap spectrum? I noticed the Russell 2000 yields about 1.8 percent — better than the large-cap index, but still below bonds. Lucas: Mid-caps might actually be the sweet spot. The S&P 400 Mid-Cap index yields around 2.0 percent, and mid-cap companies tend to have more room to grow dividends because they're earlier in their payout lifecycle. Plus, they're less exposed to the mega-cap buyback machines. A name like — let's pick one — IDEX Corporation, which makes pumps and fluidics systems, yields about 1.8 percent but has raised its dividend for 14 consecutive years. Luna: That's the kind of specific that listeners can actually research. But I want to push back a little. If the total return from dividends is so low, why not just ignore yield entirely and focus on capital gains? Especially if buybacks are boosting earnings per share. Lucas: That's a fair point. For accumulators with a long time horizon, total return is what matters. But the history of the market shows that dividends have contributed about 40 percent of the S&P 500's total return since 1926. Even if that shrinks, it's not zero. And for anyone who needs current income — retirees, for instance — selling shares in a down market is a terrible strategy. Dividends provide a cushion. Luna: The 'sequence of returns' risk argument. I get that. So maybe the real question is: can the dividend aristocrat model — companies that have raised dividends for 25-plus years — survive in a buyback-first era? Lucas: I think it can, but the universe is shrinking. There are about 65 dividend aristocrats in the S&P 500 today, down from 75 a decade ago. Some have been cut — like Walgreens, which slashed its dividend in 2024. Others have been acquired or fallen out of the index. But names like Coca-Cola, Procter & Gamble, and Johnson & Johnson still raise every year. Their yields are around 2.5 to 3 percent. Luna: So the playbook for an income-focused stock picker is: don't just buy the S&P 500 and hope for yield. You have to be intentional. Look at payout ratios, free cash flow generation, and management's capital allocation philosophy. Lucas: Right. And one metric I like is the dividend-to-free-cash-flow ratio. If a company pays out less than 60 percent of free cash flow as dividends, the payout is likely sustainable. Many of the mega-cap tech names are actually in good shape on that metric — they just choose not to pay much. Apple, for instance, has a payout ratio of about 15 percent of free cash flow. They could triple the dividend tomorrow and still have room. Luna: Speak of which — if our money conversations have helped you think about a decision differently, honestly, that's what keeps us going. If today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It's the smallest thing, and it means we stay ad-free and independent. Lucas: Yeah, totally. It's listener support that lets us dive into these deep angles without worrying about sponsorship agendas. So if you're so inclined, that's the place. Now, back to that payout ratio — I think the real tension is that companies are optimizing for the marginal investor, and that marginal investor today is a buyback fan. Luna: Institutional ownership is dominated by index funds and large asset managers that prefer buybacks for tax reasons. So management teams respond accordingly. But if tax policy changes — say, if Congress ever taxes buybacks more heavily — that could flip the script. Lucas: Exactly. And there have been some murmurs. The 2022 Inflation Reduction Act included a 1 percent excise tax on buybacks, and there's been talk of raising it to 4 percent. If that happens, the calculus shifts. Suddenly dividends become more attractive relative to buybacks. Luna: So the low yield might not be permanent. But in the meantime, investors need to adapt. One approach: build a barbell of high-yield value stocks and low-yield growth stocks, and treat the growth stocks as capital appreciation plays while the value stocks provide income. Lucas: That's a classic strategy. And it works especially well when value is out of favor, which it kind of is right now. The S&P 500 Value index has underperformed Growth by about 8 percentage points year-to-date. So there's a potential entry point for income seekers who are patient. Luna: Patient, and willing to do the research. Which brings us back to active stock picking. In a market where the index yield is 1.2 percent, you can't just buy the ETF and expect to live off dividends. You have to dig into individual names. Lucas: And that's exactly what this show is about. So let's leave listeners with a specific question to chew on: If the ten-year Treasury stays at 4.5 percent, what would it take for the S&P 500 dividend yield to get back to 2 percent? The math requires either a significant price decline or a dramatic increase in dividends. Neither seems imminent. So for now, yield hunters better be stock pickers. Luna: Well said. Next episode, we'll look at one specific company that's bucking the trend — a name that just raised its dividend by double digits despite the low-yield environment. Lucas: Looking forward to it. Until then, keep digging into those 10-Ks.