Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why Dividend Growth Beats High Yield in a Flat Rate World
Transcript
- Lucas: So there's a chart that's been bugging me all week. You look at the performance of high-yield dividend funds versus dividend growth funds over the last five years, and the gap is not subtle. The growth side is up maybe double. And in a flat rate world like we're in right now, with the Fed holding at 3.63 percent, that gap just keeps widening. Luna: You mean something like SCHD versus VYM? Because I've been seeing those two compared everywhere lately. Lucas: Exactly. SCHD, the Schwab US Dividend Equity ETF, is up about one percent over the last five days, while VYM, the Vanguard High Dividend Yield ETF, is up only 0.3 percent. But that's just the short-term noise. Over five years, the difference in total return is stark. And I think the reason is that investors are finally waking up to the fact that a high yield today often comes at the expense of growth tomorrow. Luna: And growth tomorrow is what actually builds wealth. I mean, if you're living off the income, sure, you want yield, but for most of us, it's about total return. Lucas: Right. And that's the classic trap. You see a stock like Altria, yielding north of 8 percent, and it looks like a dream. But Altria's dividend has been flat for years. They haven't raised it since 2021. Meanwhile, a company like Procter & Gamble, which yields around 2.3 percent, has increased its dividend for 68 consecutive years. And this year they raised it by 4 percent. Luna: So you're getting a 2.3 percent yield, but that yield is growing. Over time, that income compounds. Lucas: Exactly. Let's do the math. If you buy a stock with a 3 percent yield and it grows the dividend by 6 percent a year, your yield on cost after ten years is over 5 percent. After twenty years, it's over 9 percent. Meanwhile, that 8 percent yield from Altria stays at 8 percent. And if they ever cut it, you're left with nothing. Luna: And that's the real risk. A cut doesn't just reduce your income, it usually tanks the stock price, so you lose on both ends. Lucas: Which is why I think the market is starting to price in this difference. Look at the Dow, it's down half a percent over the last five days, but the S&P 500 is up. And the Russell 2000, which is full of smaller companies with more growth potential, is up 1.7 percent. That's a risk-on signal that favors companies with growth, not just income. Luna: And the yield curve steepening, with the 10-year at 4.63 and the 2-year at 4.15, that typically favors banks and cyclicals, but it also signals that the market expects growth ahead. Lucas: Yeah, and that's the backdrop. But I want to get specific about a few names because I think there's a real lesson here. Take Johnson & Johnson. It's down about 0.6 percent over the last five days, but the dividend is rock solid. They've raised it for 63 straight years. The yield is around 3.1 percent, which is actually decent for a healthcare giant. And their earnings growth is steady, so that dividend increase is sustainable. Luna: And compare that to Altria, which has been cutting its workforce and facing declining volumes. The dividend is a trap because it's not backed by growth. Lucas: Exactly. And that's the key metric to look at: the payout ratio. If a company is paying out 80 or 90 percent of its earnings as dividends, there's no room to raise it, and any hiccup in earnings could force a cut. Altria's payout ratio is over 80 percent. Procter & Gamble's is around 60 percent. Johnson & Johnson's is around 45 percent. Luna: So you want to see a payout ratio that's high enough to be meaningful but low enough to allow for growth. That's the sweet spot. Lucas: Right. And that's why I think dividend growth ETFs like SCHD are the better choice for most investors. SCHD's portfolio is built around companies with a long history of consistent dividend growth and strong financial health. It yields around 3.5 percent, which is lower than VYM's 3.9 percent, but its dividend has been growing at about 8 percent annually. So over time, your income from SCHD will surpass VYM's, not to mention the capital appreciation. Luna: And that's really the point of this episode. It's not about the yield today, it's about the growth of that income stream over time. And I think a lot of investors, especially those nearing retirement, make the mistake of chasing yield and end up with a stagnant or even declining income. Lucas: Yeah, and we've seen this play out with the dividend aristocrats. A lot of them are in the healthcare and consumer staples sectors, like Johnson & Johnson and Procter & Gamble, which have been lagging the tech-driven market this year. But if you're a long-term investor, that's exactly the kind of boring, consistent growth you want. And with the Fed on hold, these companies are in a sweet spot: their borrowing costs are stable, and they can keep raising dividends at a healthy clip. Luna: I've also noticed that some of the higher-yielding names, like Verizon, have been doing well recently. Verizon is up 3.1 percent over the last five days. Is that a sign that the market is starting to appreciate the safety of those yields? Lucas: Possibly. Verizon is a special case. It's got a high yield, over 6 percent, but it's also got a lot of debt from the 5G buildout. However, their free cash flow has been improving, and they've maintained their dividend for years. So the market might be giving them credit for that stability. But even so, the dividend growth is minimal. You're getting a high yield but very little increase, so your real income, adjusted for inflation, is going down over time. Luna: So it's really about that real income. And in a world where inflation is around 2.5 percent, a 3 percent dividend that grows by 6 percent a year gives you a growing real income, whereas a 6 percent dividend that never grows actually declines in real terms. Lucas: Exactly. And let's not forget about the total return aspect. When you buy a dividend growth stock, you're getting both income and capital appreciation. Over the last decade, dividend growth stocks have outperformed high-yield stocks by a significant margin. And that's what builds wealth. Luna: So for someone just starting to build a dividend portfolio, what's the practical takeaway? Should they just buy SCHD and call it a day? Lucas: Well, SCHD is a solid core choice, but I'd also look at individual names that fit the criteria: a payout ratio under 60 percent, a history of at least 10 years of dividend increases, and a business model that can sustain that growth. Companies like Procter & Gamble, Johnson & Johnson, and even some industrials like Caterpillar, which has been raising its dividend for decades. The key is to focus on the growth of that payment, not just the initial yield. Luna: And to be patient. Dividend growth compounds over time, but it takes years to see the full effect. It's not a get rich quick scheme. Lucas: Right. And that's why this podcast is ad-free, by the way. We're not here to sell you anything. If you find these conversations useful, and you want to support the work we do, you can buy us a coffee at buy me a coffee dot com slash fexingo. It's a simple way to keep the show free for everyone. Luna: Yeah, and we really appreciate that kind of support. It helps us keep doing what we love, which is breaking down these confusing topics for you. Lucas: So back to the practical side. One thing I like to do is look at the dividend growth rate of a company over the last 10 years. If it's been consistently growing at 6 percent or more, that's a good sign. And then I check the payout ratio to make sure they have room to keep going. Luna: And what about the yield curve? We've been mentioning that it's steepening. How does that play into this? Lucas: Well, a steeper curve typically means the market expects higher growth and inflation in the future. That can be a headwind for high-yield stocks, because if growth picks up, those companies might start investing in growth instead of paying out dividends. But for dividend growth companies, it's a tailwind, because they have the earnings to raise dividends faster. Luna: So the steepening curve is actually a positive signal for the type of stocks we're talking about. That's a good point. Lucas: And let's not forget the current rate environment. With the Fed on hold, borrowing costs are stable, which is good for companies that need to finance growth. And with Treasury yields still below 5 percent, dividend stocks still offer a compelling alternative for income seekers. Luna: But you have to be selective. Not all dividend stocks are created equal. Some, like the mortgage lender we talked about in a previous episode, cut their dividend because they were overleveraged. That's a reminder to always look under the hood. Lucas: Absolutely. And that's why we keep coming back to the same principles: focus on dividend growth, payout ratio, and the company's ability to sustain that growth. It's not about the highest yield, it's about the highest total return you can get over the long run. Luna: So if I had to pick one takeaway from this episode, it would be: don't be seduced by the high yield. Look for the growth story behind the dividend. Lucas: Exactly. And with that, I think we've given everyone plenty to think about. Next time you're looking at a dividend stock, ask yourself: is this yield going to be higher in five years? If the answer is no, maybe it's not the right choice for your income portfolio. Luna: That's a great way to put it. Thanks for listening, and we'll catch you in the next episode.