Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why Dividend Growth Beats High Yield Now
Transcript
- Lucas: Look at the ten-year Treasury right now. It’s hovering around four point nine five percent, down slightly from last week but still firmly entrenched in the high four percent range. For decades, we’ve been told that a safe dividend stock needed to offer a yield that beat this benchmark. But if you look at the S&P five hundred today, specifically the high-yield subset, a lot of those payouts aren’t just failing to beat Treasuries—they’re barely covering inflation. Luna: Right, and I’ve seen some of the data on the defensive names. When a company offers a six or seven percent yield but hasn’t raised its dividend in three years, that’s not income, that’s a value trap waiting to happen. Lucas: Exactly. And here is the thing most listeners miss: the cost of capital has shifted. With the Fed Funds rate effectively sitting at three point six three percent and short-term borrowing costs creeping up toward four percent, companies can no longer afford to fund stagnant dividends through debt. They have to grow their earnings organically to justify the payout. That means we need to stop looking at the current yield and start looking at the dividend growth rate over the last five years. Luna: So you’re saying the metric that matters isn’t the check you get today, but the speed at which that check grows? Lucas: Precisely. Let’s take Procter and Gamble. Their yield is respectable, maybe around two point five percent, but they’ve increased their dividend for over seventy consecutive years. In an environment where the real return on your cash is being eroded by persistent core inflation, that compounding growth is the only thing that preserves purchasing power. Contrast that with a telecom or a utility that might offer eight percent but has cut or frozen payouts recently. One is a wealth builder; the other is a decaying asset. Luna: It feels counterintuitive when you’re trying to cover monthly expenses, but mathematically, you’re absolutely right about the compounding effect. Lucas: Before we dig deeper into the specific sectors where this divergence is widest, I want to mention something real quick. A small group of our listeners supports the show monthly through buy me a coffee dot com slash fexingo, and that support literally funds the research time it takes to verify these numbers against the latest filings. It keeps the podcast ad-free and allows us to focus on the deep dives rather than chasing clicks. Luna: Yeah, it makes a huge difference. Knowing we have the bandwidth to actually read the quarterly reports instead of just skimming headlines changes everything we talk about here. Lucas: Absolutely. So, let’s drill into the consumer staples sector, because that’s where the battle is being fought right now. We know inflation has cooled from its peak, but prices remain elevated. Companies like Procter and Gamble have had to raise prices aggressively to maintain margins. The question is: do they have pricing power left, or are consumers starting to trade down to generics? Luna: I’ve noticed some chatter about private label market share gaining ground in grocery stores. If volume drops even slightly, does that threaten the dividend sustainability? Lucas: It’s a valid concern, but look at the balance sheets. Procter and Gamble operates with extremely low leverage compared to the broader market. They generate massive free cash flow relative to their payout ratio. Even if volume growth slows to zero, their ability to maintain the dividend is backed by operational efficiency gains. They’re cutting costs internally to protect the shareholder return. That’s why their dividend growth rate remains in the double digits percentage-wise over the last five years, significantly outpacing the yield itself. Luna: So the safety margin comes from low debt and high cash conversion, not just top-line revenue growth? Lucas: Exactly. Now, compare that to the healthcare sector, specifically Johnson and Johnson. Their yield is lower, often below two point five percent, but their history is arguably even more impressive. Despite recent legal headwinds and restructuring costs, they’ve continued to raise the dividend annually. The key here is diversification. JNJ isn’t just one product line; it’s pharma, medical devices, and consumer health. This diversity smooths out earnings volatility, making the dividend incredibly resilient even when interest rates rise. Luna: But doesn’t the rising interest rate environment hurt their ability to refinance any existing variable-rate debt? That should squeeze margins. Lucas: It does, which is why we see them locking in fixed-rate debt whenever possible. And honestly, the market has already priced in much of that risk. The stock price for Johnson and Johnson has been relatively stable, trading in a tight range, which suggests investors aren’t fleeing the quality. They’re holding it as a bond proxy. But remember, a bond proxy only works if the issuer can keep paying. That’s why the dividend growth rate is the leading indicator. If JNJ’s growth rate starts to flatten, we’ll know the margin pressure is becoming unsustainable before the actual cut happens. Luna: That’s a great point. Most people watch the stock price for signals, but the dividend history is the lagging confirmation of financial health. Lucas: Right. And this brings us to a critical distinction for your portfolio construction. If you build a portfolio based solely on high yield, you are essentially buying declining businesses. You’re collecting a larger coupon because the market expects less growth. But in a world where the ten-year Treasury is nearly five percent, that expectation of decline is dangerous. You need exposure to companies that can grow their earnings faster than inflation. Luna: So we’re essentially arguing for a total return mindset, even within an income-focused strategy? Lucas: Completely. Total return includes both the dividend and the capital appreciation driven by earnings growth. A company growing dividends at ten percent per year will eventually surpass the yield of a stagnant stock offering seven percent. It’s simple arithmetic. By year five, the high-growth stock’s yield-on-cost is significantly higher, and the principal value has likely appreciated due to stronger earnings multiples. The high-yield stock? It’s probably flat or down, and the dividend is at risk. Luna: It forces you to be patient. You’re accepting a lower initial yield for a much higher future stream of cash. Lucas: Yes, patience is the premium you pay for quality. And this is particularly relevant given the headlines we saw this week about Berkshire Hathaway. Warren Buffett stepping down as chairman highlights the importance of succession and capital allocation discipline. His successors are known for prioritizing long-term compounders over speculative high-yield bets. It’s a signal that the institutional money managers who matter are also shifting toward durability over immediacy. Luna: I think a lot of retail investors struggle with that patience. They see a five percent yield and feel secure, not realizing they’re taking on equity risk without the equity upside. Lucas: That’s the trap. They think they’re being conservative by buying high yield, but they’re actually exposing themselves to capital destruction. If the dividend is cut, the stock usually crashes thirty percent or more overnight. You lose both the income and the principal. Whereas a dividend growth stock might dip ten percent during a correction, but the trend line remains intact, and the next year’s payment is higher than the last. Luna: So the advice for listeners right now is to audit their portfolios for stagnation. Look for companies that haven’t raised their dividend in three or more years. Lucas: Spot on. And cross-reference that with their debt levels. If a company has high debt and a flat dividend, run. If a company has low debt and consistent raises, hold or add, even if the current yield seems low compared to the ten-year Treasury. In late September twenty twenty six, with rates sticky and inflation persistent, growth is the only reliable hedge. The market is rewarding durability, not desperation. Luna: It’s a subtle shift in mindset, but once you make it, it changes how you evaluate every single stock you look at. Lucas: It does. And that’s the edge. While everyone else is chasing the highest yield available, you’re building a portfolio that pays you more every single year, regardless of what the Fed does or what the Treasury market does. That’s the difference between surviving inflation and thriving through it. Luna: Thanks for walking us through that. It’s a much clearer framework than just looking at the percentage screen. Lucas: Happy to help. Next week, we’ll look at how REITs are adjusting their capital expenditure plans in response to these same rate pressures. Stay tuned.