Ep. 118: The Income That Lasts vs. The Income That Fades

So right now there are stocks and funds out there offering, you know, a massive 14, 15,
even 17% yield.
Yeah, it's crazy.
It feels like free money just sitting on the table, but high yield investing is, well,
it's not a standard bank account.
It's more like a game of mine sweeper.
Oh, absolutely.
One wrong click on a yield that's actually just a mirage and your capital completely blow
up. It is arguably the most dangerous illusion in the stock market because, you know,
the yield is really just a math equation.
Right.
It's just the dividend divided by the stock price exactly.
And so often that yield a skyrocketing only because the underlying stock price is
just an absolute free fall, which is exactly why today we were taking a massive stack
of top tier investing sources.
We've got Morningstar reports, executive interviews, insights from top dividend channels
and we're doing this deep dive to answer the only question that really matters for a smart
retail investor.
How do you tell the difference between income that lasts and income that just fades?
Exactly.
I want to hand you the listener a metal detector for this high yield mine field.
I love that analogy.
And to use that metal detector, I mean, we really have to start interrogating the source
of the cash.
Yeah.
We have to figure out if the dividend check you're receiving is actually funded by a thriving
cash generating business or if it's just being synthetically engineered, just to keep
you invested.
Right.
And to spot those synthetic traps, we first need to know what a safe patch of ground actually
looks like.
I was looking through Morningstar's recent reports on what they call the burden hand appeal
of dividends.
Yeah.
That burden hand concept is so important.
It really is, especially for someone in retirement, getting a cash deposit is just psychologically
safer than, you know, deciding which of your shares you have to sell off this month.
But they emphasize you can't just sort by the highest yield and call it a day.
No.
Definitely not.
Morningstar's criteria for a durable retirement stock is actually pretty strict.
I mean, they are looking for a yield of 4% or more or sure.
But the company also has to be trading well below their fair value estimate.
And most importantly, they need a bullet proof track record of covering that cash payment,
regardless of the macroeconomic environment.
And one of the stalwarts they flagged on this list actually caught me off guard.
Chlorox ticker CLX, I mean, they make bleach and trash bags.
Yeah, not exactly glamorous.
No, not at all.
So how does that translate into a durable 5% yield we can actually trust?
Well, you have to look at what they've weathered.
I mean, they survived the post pandemic volume hangover when, you know, everyone suddenly
stopped buying sanitizers.
Oh, yeah.
That was brutal.
Right.
And they navigated massive supply chain inflation.
They even took a huge hit from a cybersecurity breach recently.
Yet Morningstar has them trading roughly 38% below $155 fair value estimate.
Wow, 38% below.
Yeah, but the metric that actually matters for your metal detector is their payout ratio,
which analysts expect to stabilize around 60% long term.
OK, let's pause right there because we hear payout ratio thrown around constantly.
Why is 60% the magic number for durability here?
So think of it like a household budget, a 60% payout ratio means management is taking
all their profit, giving you 60 cents on the dollar and intentionally locking the
other 40 cents inside the corporate vault.
Just keeping it as a buffer.
Exactly.
They use that 40% to reinvest in new products, pay down corporate debt or, you know,
just build a massive cushion for the next crisis, which makes sense because if
the company is paying out 95% of its profits, they have zero margin for error.
Precisely.
That 40% buffer is what prevents a dividend cut when a recession inevitably hits.
That makes total sense.
You see a similar defensive posture with PepsiCo.
I mean, it's a literal dividend king.
50 plus years of continuous raises, growing that dividend at over 7% a year recently.
Pepsi is a powerhouse or real estate income ticker.
Oh, which literally trademarked the phrase the monthly dividend company.
They did.
But you know, both of those are classic, backward looking indicators of quality.
You're essentially trusting them because of what they achieved over the last decade or two.
Right, which brings me to this brand new ETF that launched in July, 2026.
The amplify S&P 500 dividend drivers ETF ticker, DRVR because they are trying to
flip that backward looking script entirely, right?
It is a total fundamental shift in methodology, a standard dividend growth ETF, just, you
know, scans the market for companies that raised their payout of last 10 years, just looking
at the history exactly.
But DRVR ignores the past.
They leverage 40 different analysts from S&P global to actively forecast the next 12 months
of dividend growth, and they use that to filter the entire S&P 500 down to just 50 stocks.
You know, the amplify CEO using analogy absolutely loved.
He said, most dividend funds are driving a car by staring in the rear view mirror.
But DRVR is actually looking through the windshield that is the perfect way to describe it.
They filter those 50 stocks based on forecasted yield and forecasted dividend growth rate.
But the heavy lifter in their formula is a five year average return on invested capital,
ROIC.
Yes, ROIC is massive.
But I know we're hunting for yield.
So why are they so obsessed with ROIC?
Does this forecasting actually work better than a basic index?
Well, return on invested capital is the actual engine inside the car.
If a company takes a million dollars of capital, builds a new factory or launches a new product,
ROIC measures how much cash that specific investment generates.
So it's about efficiency.
Exactly.
If a business cannot generate a high return on its own internal investments, it cannot compound
its earnings.
And if earnings don't compound, the dividend will eventually flatline.
So buying a company with high ROIC is essentially proving that the underlying business is actually
thriving, not just treading water.
Historically, yes, in back testing, the specific index DRVR tracks generated a 25% higher dividend
growth rate than the broader S&P 500 over time.
Wow, 25% higher.
Yeah, higher ROIC creates the excess cash that eventually becomes your dividend hike.
OK, so if a strong return on invested capital is the ultimate shield for our portfolio,
what does it look like when that shield starts to crack?
That's where things get dangerous.
Right, because I'm looking at a recent breakdown from Ryan's dividend channel.
And he is waving massive red flags at a few companies because, you know,
companies don't just wake up and slash their dividend for fun.
No, a cut is always the final act of a long, painful financial play.
The cracks always show up in the underlying cash flow month, sometimes years.
Before management actually issues the press release, take veil resorts.
For example, ticker MTN.
Yeah, a huge operator of ski resorts yielding 5.65%.
I mean, on paper, that looks like a fantastic juicy yield for a premium brand.
It looks tempting until you actually open the hood.
Their free cash flow margin has collapsed from 21% down to roughly 6%.
Wait, let's unpack free cash flow margin for a second.
How is that different from just standard profit?
Good question.
Standard accounting profit includes a lot of, well, non cash adjustments,
depreciation and future promises.
Free cash flow is the cold hard cash left in the register after the company has paid
all its bills and maintained its ski lifts and lodges.
Okay.
So the margin is just what percentage of their revenue actually turns into that raw cash?
Exactly.
Dropping from 21% to 6% means the business is suddenly incredibly inefficient at creating
actual dollars.
And that explains why their dividend hasn't moved an inch since April 2024.
They are completely frozen.
Yeah, they are stuck.
But Ryan pointed out something even scarier in their payout ratio.
They are now paying out more in dividends than they are generating in that free cash flow.
It is a mathematical time bomb.
Oh, you are bleeding cash.
Yeah.
And we're seeing a very similar dynamic playing out with Papa John's ticker PZZA.
Oh, yeah.
As Ryan quipped, the PZZA might be hot, but the dividend has gone freezing cold.
They're yielding nearly 6%, but the payout ratio recently spiked to 132%.
Let that sink in for everyone listening.
132% they are literally paying out 32% more money than they actually bring in.
The only way a company bridges that 32% gap is by draining their cash reserves or swiping
the corporate credit card, which brings up the most fascinating red flag on Ryan's list.
Robert half ticker RHI.
The massive staffing agency.
This one is a great case study.
It really is.
They have a 21 year streak of consecutive dividend raises.
They are just four years away from becoming an official dividend aristocrat.
Yep.
But recently their earnings per share and free cash flow have fallen off an absolute cliff.
But here's the thing.
I looked at their balance sheet.
Robert half has zero debt.
None, right.
So couldn't they just go to the bank, borrow some cheap money, keep that 21 year streak alive.
And essentially buy their way into the aristocrat club.
I mean, they could absolutely secure a loan tomorrow.
But I want the investor listening to this to really think about the visceral reality of that scenario.
Do you want the management team of a company you own going to a bank,
taking out a loan with a six or seven percent interest rate,
just so they can hand that barred cash directly back to you as a dividend?
Wow.
When you frame it like that,
I am essentially paying the interest on my own dividend check just so the CEO looks good on paper.
It is the purest definition of engineered yield.
You are starving the future of the business,
saddling it with debt to maintain a complete illusion in the present.
That's crazy.
If free cash flow doesn't cover the payout, the income is fading period.
That is a phenomenal mental model.
But it forces a really difficult question.
If a six percent yield at Papa John's or Vale is a land mine,
does that mean all high yield is a trap?
Not necessarily because I am looking at the mid-year high yield scorecard from Zividendology.
And there are some massive yields out there that seem perfectly healthy.
Right. Not all high yield is dangerous.
You just have to fundamentally understand the legal and tax structures of the asset class that's funding that yield.
Okay. Explain that.
Well, standard C corporations like Papa John's paid double taxes at the corporate level.
And then when you receive the dividend, but certain structures bypass that entirely.
Let's start with MLPs, master limited partnerships.
dividend-dology highlights energy transfer, ticker ET and Western midstream ticker WES.
Yep, those are big ones.
Yielding roughly 6.7% and 7.8%.
If Microsoft yielded 7.8%, we would assume the company was going bankrupt.
We absolutely would.
But with MLPs, the math is totally different.
Exactly because you do not evaluate an MLP using standard earnings per share.
They own massive pipelines and storage tanks,
which means they have billions of dollars in depreciation every single year.
Right. Big physical assets.
Yeah. And that depreciation is an accounting trick that makes their standard earnings look artificially terrible.
Instead, you have to measure them on distributable cash flow or DCF.
So we take the cash they actually made and just add that fake depreciation charge back into the equation.
Precisely. And when you do that with energy transfer, they generate $2.38 in DCF per share.
But they only pay out $1.34 distribution.
That is incredible coverage. They have over $1 per share and buffer.
And I really love the underlying business model here.
Investing in a midstream pipeline is essentially like owning an interstate toll booth.
It is a perfect analogy.
You don't actually care if the price of gas at the pump is $4 a gallon or $2 a gallon.
You just sit at the booth and collect a fixed fee for every single barrel of oil that passes through your infrastructure.
And that cash flow is heavily insulated from volatile commodity prices because of those fee-based long-term contracts.
Great.
Now, another asset class built entirely on its legal structure is REITs.
Real estate investment trust.
Oh, yeah. Real estate.
Or by law, a REIT must pay out 90% of its taxable income to shareholders.
In exchange, the company itself pays zero corporate income tax.
And just like the pipelines, REITs have massive depreciation on their building.
So can't use standard earnings there either, right?
Exactly. We use adjusted funds from operations, AFFO.
It strips out all that depreciation noise to show you the actual rental cash flow.
And VCI properties is a great example on this scorecard.
Yielding 6.8%.
They own massive swaths of the Las Vegas strip, Caesars, MGM.
Right. Huge properties.
And even when Vegas tourism took a temporary dip,
VCI's AFO growth just kept climbing.
Because they aren't running the casinos,
they are just collecting the rent checks.
It's a much more stable position to be in.
Or look at AH Realty Trust.
Ticker AHRT.
They had to cut their dividend recently during a huge strategic pivot
away from developing new buildings.
Which obviously hurts the stock price in the short term.
It does.
But by abandoning risky development projects,
their new lower dividend is completely covered strictly
by their recurring rental income.
Oh.
Yield is smaller, but it is deeply durable.
The scorecard also touches on BDCs, business development companies.
Like Aries Capital, Ticker IRCC, yielding a massive 10%.
BDCs are essentially shadow banks.
They lend money to mid-size private businesses
that regular banks just ignore.
Right.
And like REITs, they pass the majority of their income straight to you.
IRCC is fully covering its 10% dividend
with its net investment income.
And right now, it is trading below its tangible book value.
Meaning I could buy a dollar's worth of their underlying loan assets
for about $0.97.
Okay, I track with the toll booths, the casinos, the shadow banks.
But I have to throw a flag on one of the REITs on this list.
New Lake Capital Partners, Ticker NLCP.
I had a feeling you'd bring this one up.
I mean, it is an 11% yield in cannabis real estate.
An 11% yield in an industry that is still federally illegal
sounds absolutely terrifying to me.
How on earth is that durable?
On the surface, it looks like the biggest mine on the board.
Yeah.
But there is a massive macroeconomic shift happening
beneath the surface here.
Yeah.
The federal government has begun the process of moving cannabis
from a Schedule 1 drug down to Schedule 3.
Okay.
That reclassification fundamentally ulcers the math for New Lake's tenants.
Wait, how does changing a drug schedule help a real estate landlord?
Well, under Schedule 1,
cannabis operators are subjected to a tax code called 280E.
It legally prohibits them from deducting normal business expenses
like payroll or marketing from their federal taxes.
Oh, wow.
Because of that,
these operators face crippling effective tax rates of 60,
sometimes 80%.
80% taxes just to keep the lights on.
No wonder they struggle to pay rent.
Exactly.
Moving to Schedule 3 eliminates 280E.
Their tax burden normalizes overnight.
The business has suddenly become highly profitable,
which drastically improves their credit quality.
Uh, and if the tenant is flush with cash,
your rent check is perfectly secure.
Bingo.
That massive 11% yield reflects the historical regulatory terror,
but the underlying fundamentals are rapidly catching up.
All right, so we know how to interrogate these individual stocks and structures,
but let's be realistic.
A lot of everyday investors don't want to read balance sheets all weekend.
No, they definitely don't.
They want to package these concepts into an automated ETF income engine.
Doug, the retirement guy laid out a brilliant three-bucket strategy
using ETFs for this exact purpose.
Yeah, Doug categorizes these funds strictly by their function in your portfolio.
For the core income bucket, he points to SPYI,
which yields nearly 12%.
12% for a core bucket.
Yes.
It holds standard S&P 500 stocks,
but it generates that massive yield by selling out-of-the-money call options against the index.
Okay, I need to stop you there, because he also mentioned SPYI uses something called
12.56 contracts for tax efficiency.
What is a 12.56 contract?
And why should a retail investor care?
So it is a special IRS tax designation for certain index options.
Normally, if you sell a covered call and hold it for less than a year,
you pay high short-term capital gains tax on the profit.
Right, ordinary income rates.
Exactly.
But if a fund uses 12.56 contracts,
the IRS automatically treats 60% of those profits as long-term capital gains,
regardless of how short the holding period was.
Oh, that's huge. So I'm getting a 12% yield,
and a huge chunk of it is taxed at a much lower friendly rate.
That is a fantastic core holding.
It really is.
Doug then uses SHD, the Schwab US dividend equity ETF for his growth sleeve.
Now, SHD only yields around 3.3% today, which sounds kind of boring,
but it is filled with high ROIC compounders.
It is a long-term engine for future wealth.
Absolutely.
However, he issues a massive warning sign on his third bucket,
JPI, yielding 8.2%, Doug literally calls it a conservative trap.
JPI is fascinating because it doesn't sell standard options.
He uses something called equity linked notes or ELNs
to actively suppress the volatility of the fund.
Okay, another piece of heavy jargon.
Explain an ELN to me like I'm five years old.
Imagine going to a major bank and saying,
I will give you my money and you promise to pay me a return
based on how the S&P 500 performs.
Okay.
But in exchange for a guaranteed high yield today,
I agree to let you keep any market gains above, say, 5%.
The bank issues a literal debt note in ELN with those specific terms.
So the bank pays me my 8% yield, but they cap my upside.
Yes, and that is exactly why JPI is a trap in a bull market.
The ELN smooth out the ride when things are turbulent.
But when the S&P 500 rockets up 20%,
JPI mathematically cannot follow it.
You basically traded the rocket ship for a parachute.
Exactly.
Lower volatility does not mean principal protection.
It just means you're intentionally missing out
on the market's long-term growth.
Which brings us to the absolute wildest part of today's deep dive.
If JGPI capping your upside is a trap,
we really have to talk about the new wave of manufactured yield.
We're looking at a piece from informed investing
that compares to aggressive covered call ETFs.
TDAQ and QDTE.
These are getting a lot of attention right now.
Yeah.
TDAQ is currently reporting an annualized distribution run rate of 14% to 17%.
It is an eye-watering figure.
Now, TDAQ holds actual NASDAQ 100 shares via the QQ QMETF.
That's a point in its favor compared to QDTE,
which relies on purely synthetic option positions.
But TDAQ generates that 14% to 17% yield
by writing zero-deased expiration or zero DTE
covered calls on those holdings every single day.
Literally every single day.
Every day.
Selling a covered call is essentially like renting up the upside of your house.
You get a guaranteed fat rent check handed to you today.
But if the house triples in value overnight,
you don't get to keep a single dime of that new profit.
You sold that right away for the rent check.
But I have to ask the obvious question.
If S2Yi pays 12% and TDAQ pays 14% to 17%,
why would anyone in the right mind
bother holding SCHD for a measly 3.3%?
Because you have to look at what you are actually being paid with.
TDAQ's 14% to 17% distribution is not coming entirely
from underlying corporate profits.
The companies in the NASDAQ are simply not generating enough free cash flow
to pay you 17%.
Right.
That math doesn't work.
A massive portion of that distribution is simply option premium
and worse, return of capital.
Wait, return of capital.
You mean they are literally taking my own principal investment,
handing it back to me and calling it a yield?
That is exactly what return of capital is.
You hand them a dollar.
They hand you 15 cents back and say,
look at this amazing 15% yield.
That's wild.
Capping your daily upside with zero DTE options
trades long-term wealth creation for immediate taxable cash.
SCHD yielding 3% is a seed you plant to fight future inflation.
The companies inside SCHD are growing their real earnings,
which increases their real dividends over time.
While TDAQ is essentially eating your seed corn today.
Exactly.
You are getting a fat distribution, yes.
But it is fundamentally engineered, not earned.
So what does this all mean for us?
We have covered a massive amount of ground today,
but the throughline here is crystal clear.
Income that lasts is built on a foundation of strong return on invested capital.
Yes.
It comes from resilient, fee-based business models
and payouts that are fully covered by actual cold, hard, free cash flow.
We see that durability in Morningstar's Chorox pick,
the forward-looking analyst of the DRVR ETF,
and the toll-boothed economics of an MLP-like energy transfer.
And on the other side of the ledger,
income that fades always flashes warning signs in the cash flow before it breaks.
It shows up as plummeting free cash flow margins,
like we saw in Vale Resorts and Papa Johns.
Or it relies on synthetically capping your market upside,
just to manufacture a high daily distribution like PDAQ.
So here is my direct call to action for you this week.
I want you to pull up your brokerage account and take a hard,
objective look at your own portfolio.
It's a great exercise.
For every fat yield you own, you need to ask yourself,
is this funded by a thriving, growing business,
or is it synthetically engineered?
Are you collecting a true share of corporate cash,
or are you paying the interest on your own dividend check?
And to push that thought even further,
I want you to think about those massive 14% to 17%
zero DTE covered call funds we just unpacked.
Funds like TDAQ launched very recently.
They have never once been tested in a severe multi-year bear market.
Oh man, that is terrifying thought.
What exactly happens to that manufactured yield when the underlying Mazda drops 30%,
market volatility dries up,
and those daily option premiums completely vanish.
Are you really going to get paid a 17% income,
or is the fund just going to aggressively hand you back your own rapidly shrinking money?
Exactly.
It's something you really need to ponder before you allocate your next dollar,
because like we said at the very beginning,
high yield investing isn't a DTE account.
It is a game of mind sweeper.
Watch your step.