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 the Fed's been on hold for months now, and the ten-year is hovering around four-point-six-five percent. That flat rate environment is doing something weird to dividend stocks — it's making the biggest yields look the most tempting, but they're not the ones actually paying you over time. Luna: You mean like Verizon? It's sitting at a yield north of six percent, and everyone's eyeballing it as a bond replacement. Lucas: Exactly. And look, I get the appeal. But when the yield is that high, the market is pricing in risk. Verizon's payout ratio is over seventy percent of earnings, and their free cash flow coverage is thin. You're getting paid a big check today, but the dividend growth is basically flat. Meanwhile, Johnson & Johnson yields around three-point-two percent — less sexy, but they've raised the dividend for over sixty years straight, and they just bumped it again this spring. Luna: So you're saying the lower yield is actually the better income stream over time? Lucas: That's the whole episode, yes. And before we dig in — a quick honest thing. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds us making this many of these shows. No ads, no sponsors, just listeners who find the conversations useful. Luna: Yeah, we keep it independent that way. It's a small group, but it keeps the lights on and the research budget intact. Lucas: Right. So back to it. In a flat curve, the temptation is to reach for yield because bonds aren't giving you much more than three percent. But the math on dividend growth is forgiving if you give it time. Luna: Give me the numbers. What's the actual difference between a six percent yield with no growth and a three percent yield growing at seven percent? Lucas: So over ten years, that six percent no-growth payer hands you sixty cents on the dollar in cumulative dividends. The three percent grower at seven percent compounds to about fifty-four cents — but now the yield on your original cost is over five and a half percent, and next year it'll be higher. The growth payer crosses over around year eight or nine, and then it just keeps pulling away. Luna: So the tortoise beats the hare, but only if you're patient. And that's where most people mess up — they sell right at the crossover point. Lucas: Exactly. And that's why I want to look at a few real names right now. Altria is the classic trap. It yields over eight percent, but the stock is down almost four percent in the last five days alone. The market is screaming that the dividend is at risk. Their payout ratio is over eighty percent, and they're fighting declining volumes and regulatory headwinds. Luna: And yet people still buy it for the income. I mean, eight percent is hard to ignore. Lucas: It is, but that's exactly the trap. When a yield gets that high, it's often a warning, not a gift. The market is pricing in a cut, and if that cut comes, you lose both the income and the principal. It's a double hit. Luna: So what's the screen? How do you tell the safe high-yielder from the trap before it's too late? Lucas: First, look at the payout ratio relative to free cash flow, not just earnings. A company can report earnings but not actually generate the cash to pay the dividend. Second, check the dividend growth rate over the last five years. If it's been flat or shrinking, that's a red flag. Third, look at the debt load — if they're borrowing to pay the dividend, that's unsustainable. Luna: And that's why Johnson & Johnson looks solid. Their payout ratio is around fifty percent, they generate massive free cash flow, and they've been growing the dividend for decades. It's boring, but it works. Lucas: Boring works. And that's the case for the Dividend Aristocrats as a group. They've raised dividends for at least twenty-five consecutive years, which means they've survived recessions, rate spikes, and pandemics. In a flat rate world, they give you modest yield but reliable growth. And over time, that growth is what beats the high-yield trap. Luna: But not all aristocrats are created equal, right? Some are better positioned than others. Lucas: Right. Look at Procter & Gamble. It's an aristocrat, but it's down over one percent in the last five days while the S&P is basically flat. They're facing input cost pressures and a stronger dollar that's hurting overseas revenue. Their dividend growth has slowed to around four percent. It's still solid, but it's not the growth engine it used to be. Luna: So even the aristocrats need a closer look. It's about the growth rate, not just the streak. Lucas: Exactly. The streak tells you they've been reliable, but the growth rate tells you what the future looks like. If a company is growing the dividend at three percent and inflation is running at two-point-five, you're barely ahead. You want companies that can grow the dividend faster than inflation and have the cash flow to back it up. Luna: And that brings us to the ETFs. VYM and SCHD have been relatively flat this week, but DVY is down. What's the takeaway for someone who just wants a diversified dividend fund? Lucas: The takeaway is that dividend ETFs are not all the same. VYM tracks the broad high-yield index, so it's heavy on utilities and consumer staples. SCHD focuses on dividend growth and quality, so it tends to have better total return over time. DVY is the Dow Jones high-yield version, which often includes more value and financials. In a flat rate world, the growth-focused ones tend to hold up better because they're not as rate-sensitive. Luna: So if you're picking one, SCHD might be the smarter core holding for most investors? Lucas: I think that's a fair starting point. But the real lesson is to look under the hood. Don't just buy the highest-yielding fund. Look at the underlying holdings, the dividend growth rate, and the payout ratios. That's where the risk hides. Luna: And what about the broader market? The S&P is at seven-thousand-seven-fifty, and the Dow is nearly fifty-four-thousand. Are we in a bubble that could pop and take dividends down with it? Lucas: That's the million-dollar question. But remember, dividend stocks are less sensitive to market sentiment than growth stocks. They're valued on their ability to generate cash flow, not on future earnings potential. So in a downturn, they tend to fall less and recover faster. That's why they're a good defensive core. Luna: So the strategy is to focus on dividend growth, keep an eye on payout ratios, and not get greedy chasing the highest yield. That's the takeaway. Lucas: That's the takeaway. And for those of you who want to dig into your own portfolio, start by looking at your current holdings' payout ratios and five-year dividend growth. If you see a stock with a yield above five percent and a payout ratio above seventy percent, that's a red flag. Do your homework before you fall in love with the income. Luna: And if you're looking for a place to start, buy me a coffee dot com slash fexingo is where you can support the show and help us keep these conversations going. We'll be back tomorrow with more.