Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / How High Dividend Stocks Are a Warning Signal
Transcript
- Lucas: There's a headline from yesterday that I keep coming back to: 'Bond ETF flows surge in hunt for yield,' and a BlackRock exec says the market is 'sniffing something out.' But if you look under the hood, it's not just bond ETFs. Equity dividend funds are seeing some of the heaviest inflows we've seen in three years. And I think that tells us something uncomfortable about how defensive investors have gotten. Luna: Alright, I'll bite. Why is hunting for yield uncomfortable? Isn't that exactly what smart money should be doing when rates are uncertain? Lucas: Normally, yes. But here's the catch — the S&P 500 dividend yield just hit a 25-year low. That's not a typo. We're talking about a yield that's below one point three percent for the index as of this week. So the average stock in the benchmark is paying almost nothing. To get meaningful income, you have to go down the quality ladder or into sectors that are out of favor — and that's where the traps live. Luna: So the money flowing into dividend ETFs is essentially being forced into lower-quality names because the broad market yields are so thin. That sounds like a recipe for buying yesterday's losers. Lucas: Exactly. And there's one stock that's become the poster child for this dynamic in the last few weeks: Pfizer. The stock is down over six percent in the last five days alone. It's trading around twenty-three sixty-seven. And its dividend yield? Pushing eight percent. That sounds juicy until you ask why the stock is falling. Luna: Right. A yield that high in a mega-cap pharma company usually means the market is pricing in a dividend cut. Pfizer's payout ratio is already above ninety percent of earnings. That's not sustainable. Lucas: It's exactly the kind of situation where the income investor walks into a value trap. The dividend looks safe for another quarter or two, but the underlying business — post covid revenue collapse, patent cliffs, R&D pipeline questions — doesn't support it. And yet, money is flowing into dividend ETFs that hold Pfizer because the fund mandates are mechanically buying yield. Luna: So the very act of piling into dividend funds is keeping those stocks inflated longer than they should be. When the music stops, the ETF holders get the dividend — and then the capital loss. Lucas: That's the risk. And it's not just Pfizer. Look at the value ETFs like IWD and VTV — they've outperformed the S&P 500 over the last five days, up about one percent while the broad market dropped nearly two. That rotation out of growth into value has a logic to it, but a lot of that value basket is just stuffed with high-dividend names that are cheap for a reason. Luna: I want to push back a little. Isn't there a case to be made that some of those value stocks are genuinely mispriced? The market's been punishing anything that isn't ai related for months. A stock like JPMorgan is up three percent in five days — that's not a trap, that's a well-run bank with a solid dividend. Lucas: JPMorgan is a good counterexample. Their payout ratio is around thirty percent, they just named new co-presidents, earnings are stable. But JPMorgan's dividend yield is only about two point two percent. That's not what the yield chasers are buying. They're going for the eights and nines — the distressed signals. And that's where the problem compounds. Luna: So if I'm a stock picker looking at this environment, what do I actually do? Ignore dividends entirely? Lucas: Not ignore them, but treat them as a byproduct of total return, not the primary objective. I'd rather own a company that's reinvesting capital at high rates of return — even with a tiny or zero dividend — than one that's paying out most of its earnings to keep yield-hungry shareholders happy. The best dividend is the one that grows over time, not the one that's highest today. Luna: That's a good framework. And it circles back to something we talked about a few episodes ago — the idea that stock buybacks are a better signal of discipline than dividends. A company buying back stock when it's cheap is telling you management thinks the shares are undervalued. A company juicing a dividend to keep yield seekers on the register is often masking weakness. Lucas: Exactly. And look, I'm not saying all high-dividend stocks are bad. But when the entire market is rotating into them because the ten-year Treasury is still offering around four point three percent and equity dividend funds are promising two or three points more, you have to ask: what's the risk you're not being paid for? The answer, in Pfizer's case, is a potential thirty percent capital loss if the dividend gets cut. Luna: That's a brutal risk-reward. You're getting an extra two hundred basis points of yield but taking on the possibility of losing a third of your principal. That's not income investing — that's speculation with a dividend wrapper. Lucas: And honestly, that's the kind of conversation we try to have on this show every day — looking past the headline yield and asking what's really driving the return. If that kind of thinking has helped you approach a decision differently, whether it's about a stock you own or a fund you're considering, it's worth mentioning that listener support is what keeps these episodes ad-free and independent. A couple of dollars a month genuinely makes a difference — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: Yeah, it's a small thing that adds up. And we appreciate it. So back to the dividend question — let's talk about what a smart yield looks like in this market. Lucas: I think the place to start is with companies that have pricing power and low payout ratios. Think of a company like Microsoft — yes, the stock is down seven percent in the last five days, but the dividend yield is still under one percent. Nobody owns Microsoft for the dividend. They own it for the earnings growth and the moat. The dividend is just a bonus that grows over time. Luna: And Microsoft's payout ratio is around twenty-five percent. They could triple the dividend tomorrow and still have room. But they don't, because they'd rather reinvest in cloud and AI. That's discipline. Lucas: Right. Compare that to a company like Verizon, which is not in our data today but has historically yielded around six percent with a payout ratio over fifty percent. Verizon's revenue has been flat for years. The dividend is only sustainable if the business doesn't shrink. That's a fragile setup. Luna: So the stock picker's job in a yield-chasing environment is to separate the sustainable payers from the unsustainable ones. And one quick heuristic: if the dividend yield is more than double the company's earnings growth rate, you're probably looking at a trap. Lucas: That's a good rule of thumb. I'd add another: look at free cash flow, not just earnings. A company can report earnings that include non-cash charges, but dividends are paid in cash. If free cash flow doesn't cover the dividend, eventually something breaks. Luna: Pfizer's free cash flow has been declining since 2022. The dividend is being funded by debt and cost cuts. That's not a recipe for long-term income. Lucas: It's a recipe for exactly what we're seeing — a stock that's down over six percent in a week and yield that keeps climbing as the price falls. The market is pricing in a cut. The only question is when. Luna: So if I'm building a concentrated portfolio today, do I just avoid dividends altogether and focus on growth? Lucas: I wouldn't say avoid. I'd say prioritize total return. If a stock happens to pay a growing dividend, great. But don't let the yield tail wag the investment dog. Some of the best compounders in history — Berkshire Hathaway, Amazon — pay no dividend at all. And Berkshire's stock is flat this week while the S&P is down two percent. That's the kind of resilience you want. Luna: Berkshire not paying a dividend is actually a feature, not a bug. Buffett would rather deploy capital at high returns than hand it out to shareholders who then have to pay tax on it. That's the ultimate shareholder-friendly approach. Lucas: And that brings us full circle. The yield-chasing trade we're seeing in June 2026 is a sign that investors are scared. They're hiding in dividends because they think the megacap growth rally is over. But hiding in a bad dividend is worse than standing in a good business with no dividend at all. Luna: So the contrarian take might be to look at the megacaps that just sold off. Apple is down seven point seven percent in five days. Microsoft down seven. Alphabet down six and a half. Those stocks are cheaper than they were a week ago, and their dividends are tiny but growing. Maybe that's the real opportunity. Lucas: I think that's exactly right. The rotation out of megacap tech into value and dividends has been violent this week, but it's created a gap. If you believe those businesses are still dominant — and I do — then buying them at a seven percent discount with a small but safe dividend is a better bet than reaching for yield in a distressed name. Luna: And that's the kind of active thinking that an index fund can't do for you. An S&P 500 ETF just buys the weights. But a stock picker can decide to overweight Microsoft at three fifty-two instead of chasing Pfizer at twenty-three. Lucas: Exactly. The dividend yield on the S&P 500 is at a 25-year low, but that doesn't mean you should abandon the index. It means you should be more selective about what you own. Dividends are a signal, but they're not the signal. They're one data point in a mosaic. Luna: Alright, so let's leave listeners with one concrete takeaway. What's the one thing they should do if they're looking at a high-yield stock right now? Lucas: Look at the payout ratio on free cash flow, not just earnings. If it's above seventy percent, ask why. If the answer is 'because the stock has fallen and the yield has gone up,' that's not a reason to buy — it's a reason to dig deeper. And if you can't find a good reason, move on. There are always better places to put your money. Luna: That's a good note to end on. I'm Luna. Lucas: And I'm Lucas. Thanks for listening.