Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why Dividend Growth Beats High Yield in 2026
Transcript
- Lucas: There is this persistent idea in dividend investing that a higher yield is always better. Grab the stock paying six percent, sit back, collect the checks. But the data this summer is telling a different story. Luna: You're looking at the spread between high-yield names and steady growers? Lucas: Exactly. Take two stocks we've talked about before. Coca-Cola, ticker K-O, currently yielding about three point one percent. And Altria, M-O, yielding north of seven point five percent. On paper, Altria looks like the income machine. Luna: But over the past five days, Altria is up three point three percent while Coke is down three point two percent. That's a six point five percent spread in favor of the high yielder. Lucas: Right, and in the short run, that's real. But if you zoom out to a five-year window, Coke's total return including dividends has actually beaten Altria by a wide margin. Because Coke grew its dividend every year, while Altria's payout has been flat since 2019. Luna: So the yield on cost for a Coke holder who bought five years ago is probably closer to four percent now, while an Altria holder is still collecting that same seven and a half percent on their original investment. But the gap narrows fast. Lucas: And that's the whole argument for dividend growth over static high yield. Compounding matters. A company that raises its payout annually by six to eight percent will double your income stream in about a decade. A stagnant high yielder gives you the same check every quarter, which loses purchasing power to inflation. Luna: So how do you spot a sustainable dividend grower versus a yield trap? Payout ratio seems like the obvious first filter. Lucas: It's a good start. But the nuance is in free cash flow coverage. A payout ratio below sixty percent is generally safe, but if the company is borrowing to pay the dividend, that's a red flag. Altria's payout ratio is over eighty percent of earnings, and its free cash flow has been declining as cigarette volumes shrink. Luna: Coke's payout ratio is around seventy-five percent, but its free cash flow is massive and growing. They generate over nine billion dollars in free cash flow annually, and the dividend costs about seven and a half billion. Lucas: So it's well covered. And they've been raising the dividend for over sixty years. That consistency is a signal that management prioritizes the payout. Compare that to a company like Verizon, which yields about six percent but has a payout ratio over ninety percent and has been growing its dividend at less than two percent annually. Luna: Verizon's free cash flow has been under pressure too, from network investment and debt. The dividend growth rate tells you the board is cautious. Lucas: And that's the second filter: the dividend growth rate itself. If a company is only raising its dividend by one or two percent a year, that's essentially a flat payout in real terms. You want to see at least five percent annual growth to outpace inflation and start compounding seriously. Luna: The Dividend Aristocrats index, which tracks S&P 500 companies with twenty-five-plus years of consecutive dividend increases, has historically delivered better risk-adjusted returns than the high-yield segment. And currently, the average Aristocrat yields about two point six percent, but with a five-year dividend growth rate of around seven percent. Lucas: That's the sweet spot. A moderate starting yield combined with robust growth. Over ten years, a stock yielding three percent with seven percent annual growth will give you a yield on cost of about six percent. And that's before any capital appreciation. Luna: But the market environment right now is tricky. The ten-year Treasury yield is at four point five seven percent, and the two-year is at four point one six percent. The yield curve is flattening, which typically pressures high-duration assets like growth stocks. But it also makes high-yield dividend stocks compete directly with bonds. Lucas: Right. When you can get nearly five percent risk-free on a ten-year Treasury, a stock yielding six percent with no growth and declining free cash flow starts to look less attractive. The equity risk premium shrinks. That's why Altria's stock has been range-bound for years, while Coke's stock has appreciated steadily. Luna: So the market is rewarding dividend growth as a signal of quality and pricing power. Companies that can grow their payouts are usually those with strong brands, pricing power, and predictable cash flows. Lucas: Let's look at a practical example. Johnson & Johnson, ticker J-N-J, yields about three percent. Its payout ratio is around forty-five percent, and it has grown its dividend for over sixty years. In the past five days, J&J is down one point eight percent, but the dividend is safe and growing. Luna: Compare that to a high-yield REIT like Realty Income, ticker O, which yields about five point seven percent. Over the past five days, O is up two point four percent. So in the short term, the high yielder wins. But Realty Income's dividend growth has been slowing, averaging about three percent annually over the past five years. Lucas: And REITs are more sensitive to interest rates because they carry debt. With the ten-year at four point five seven percent, their cost of capital is higher. So the dividend growth may continue to decelerate. Luna: So for the long-term income investor, the playbook seems clear: favor companies with a track record of consistent dividend growth, a payout ratio under sixty percent if possible, and strong free cash flow coverage. And don't be seduced by a high headline yield alone. Lucas: Exactly. And there's one more metric I like: the dividend growth streak. Not just the number of years, but the rate of growth over the past five and ten years. If a company has raised its dividend by at least five percent annually over the past decade, that's a strong indicator of a compounding machine. Luna: Procter & Gamble, ticker P-G, yields about two point five percent, but has grown its dividend by about six percent annually over the past ten years. Its payout ratio is sixty percent, and it has a wide moat. That's a classic dividend growth stock. Lucas: And in the past five days, P&G is up one point one percent, while the S&P 500 is down zero point eight percent. So in a down market, these stocks often provide relative stability because investors value the reliable income. Luna: So the takeaway isn't that high yield is always bad. It's that you need to understand why the yield is high. Is it high because the stock price has fallen due to a temporary issue, or because the business is in structural decline? Lucas: And that's where the research comes in. If a stock yields eight percent but its free cash flow yield is only four percent, the dividend is likely unsustainable. On the other hand, a stock yielding three percent with a free cash flow yield of six percent has plenty of room to grow. Luna: You know, if today's episode helped clarify that distinction for even one listener, I'd say it was worth the time. And if it was worth a coffee to you, the hosts would certainly appreciate the support. Lucas: Yeah, we keep the show ad-free because we believe in straight talk about investing. If you find value in that, the simplest way to help is at buy me a coffee dot com slash fexingo. No pressure, but it does help us keep the lights on. Luna: Right. And it's a small gesture that goes a long way in allowing us to keep digging into these topics. Lucas: So back to the yield curve. With the ten-year at four point five seven and the two-year at four point sixteen, the spread is thirty-seven basis points. That's down from forty-one basis points a week ago. A flattening curve often precedes a slowdown, which makes dividend growth stocks even more attractive because of their defensive characteristics. Luna: In a recession or slowdown, companies with strong balance sheets and consistent dividends tend to outperform. And the market is already pricing that in, with utilities and consumer staples holding up better than tech. Lucas: Exactly. So if you're building a dividend portfolio for the long haul, focus on total return, not just yield. A portfolio of dividend growth stocks with a combined yield of three percent and seven percent growth will double your income in about ten years. That's the power of compounding. Luna: And if you can reinvest those dividends along the way, the results are even more powerful. Lucas: That's the real secret to dividend investing. It's not about the biggest check today. It's about the growing stream of checks over decades.