Ep. 123: Mispriced — AI Panic Markdowns, All-Time Highs, and the 18% Yield That Lost Money

Imagine buying a fund paying a massive 18% yield.
I mean, you feel like an absolute financial genius every time that quarterly dividend hits
your account.
Well, absolutely.
You're probably bragging to your friends.
Yeah.
Exactly.
You're calculating your early retirement date.
You're on top of the world.
Right.
But then you pull back the curtain and you realize the fund isn't actually generating that money
at all.
Yeah.
It's secretly just selling off your original investment just to pay you.
So you aren't making a single dime.
You're just getting your own cash handed back to you in a very expensive disguise.
It is basically the ultimate market illusion.
So welcome to the deep dive.
Today we have a massive stack of research sitting in front of us.
We're pulling from veteran fund managers, deep financial analyses.
And it's all focused on a really huge theme for anyone listening who cares about building
actual wealth.
Yeah.
And that theme is what the market is completely mispricing right now.
Exactly.
Okay.
Let's unpack this because there is a, honestly, a terrifying gap right now between real cash
flowing value and the stories investors are just kind of telling themselves.
For sure.
The market is aggressively knocking down high quality dividend growers simply because everyone
is terrified of artificial intelligence.
And at the exact same time, it's overpricing a beloved blue chip stock.
It's rewriting a retail giant purely based on momentum.
And as we just mentioned, people are chasing these manufactured double-digit yields that
quietly just destroy your capital.
What's fascinating here is that mispricing almost always happens when pure emotion like panic
over AI disrupting an industry or just this desperate blind greed for yield, it overrides
basic financial math.
Right.
People stop looking at the numbers.
Exactly.
Investors stop looking at the actual cash moving through the plumbing of a business.
You know, they start pricing in stories.
And in the financial markets, stories are usually where you lose your shirt.
Yeah, they really are.
So before we can even identify what the market is getting wrong, we really need a reliable
ruler to measure it.
We need to know what a true, solid, unshakable business actually looks like when you strip
away all that narrative.
And for that, the research points to Chris Dagnus.
Right.
The veteran from Hamlin Capital Management.
Yeah, exactly.
He's a 25-year veteran there.
Yeah.
He's got money through the dot com bust, the 2008 financial crisis, the pandemic boom,
all of it.
And his framework for identifying real value is, well, it's refreshingly ruthless.
I want to start right there.
How does he actually grade a company because he doesn't do it the way most retail investors
do?
No, not at all.
His very first rule is actually super counterintuitive for a lot of income investors.
You do not start by looking at the dividend yield.
Which is what everyone looks at first.
Right.
Everyone screens for yield.
But he says, you don't even start with the income statement.
You start with the balance sheet.
Yeah.
Specifically, you look at the debt.
Okay.
Why debt first?
Because if a company is highly levered, meaning they owe just a massive amount of money to bond
holders or banks, they lose their flexibility to minute the economic cycle turns against them.
Because the debt always gets paid first.
Exactly.
The debt gets paid first.
The shareholders get whatever is left if anything is even left.
Okay.
So you check the balance sheet.
You ensure they aren't drowning in debt.
What is the next hurdle?
Free cash flow coverage.
And we should be really specific here because a lot of people just look at accounting earnings.
Right.
The basic EPS number you see on Yahoo Finance.
Yeah.
But Dagnus demands actual cash left over like after the company pays to keep the lights on,
the server is running, the factories maintained.
Hard cash.
Hard cash.
Only after checking the debt and that raw cash flow does he apply his ultimate acid test.
He simply asks, can this company still comfortably pay this exact dividend in 10 years?
I love that.
It's kind of like when an inspector comes to a house you want to buy, you know, the flashy
AI press release that company puts out, that's just a fresh coat of paint.
Yeah.
Exactly.
It looks great, but it doesn't hold the roof up, but the dividend.
That's the inspector jumping up and down on the floorboards to see if the joists actually
hold.
I mean, paying out hard cash every single quarter proves the foundation is actually solid.
It's not rotting.
It proves the foundation and, you know, it also reinforces it.
Dagnus points out that a dividend actually functions as a governor on a management team's
capital allocation.
Wait, explain what you mean by a governor in this context like on an engine.
Yeah.
Think of it exactly like a speed limiter on an engine.
When a CEO knows they are contractually obligated to send, you know, millions of dollars out the
door to shareholders every 90 days, it forces them to be incredibly disciplined with the cash
they have left.
That makes sense.
Oh.
Because the cash physically has to leave the building.
Exactly.
They can't just go on some wild acquisition spree, buying up trendy startups.
They can't fund crazy vanity projects.
The dividend grounds the management team in reality.
But I mean, management teams are still human.
They get caught up in the hype too, right?
Because the research highlights some pretty massive dividend traps recently where companies
just completely lost that discipline.
Oh, they absolutely do.
Yeah.
The point is directly at UPS as a prime example of a yield trap.
UPS?
Yeah.
Think back to the pandemic.
Everyone was trapped at home, ordering everything online.
UPS experienced this massive, just unprecedented boom in shipping volume.
Right.
They were printing money.
They were.
But instead of viewing that as a temporary anomaly, management treated it like it was the
new permanent baseline.
So they bumped their dividend by 40 to 50% in a single year.
Wow.
I mean, feels amazing if you hold the stock at that moment.
Sure until reality sets back in, you know, the world opened back up, shipping volumes normalize,
their earnings compressed back to historical averages, and suddenly that massive dividend
became a huge burden.
Ah, so they couldn't sustain it.
Right.
Now they're barely growing it at all.
The research also points to Ken Agra, the massive food brand, which just had to outright
cut its dividend.
When you chase temporary spikes, you eventually hit a wall.
So if pandemic darlings and packaged foods aren't passing the 10-year test right now, where
is Dagnus actually finding value?
Like where is the market looking the wrong way?
He sees tremendous mispricing in the energy sector right now.
It's currently trading at a very cheap valuation of just 13 times earnings.
13 times.
Which I guess that makes sense on the surface, right?
The dominant story everywhere is that we're moving to renewables.
The market treats oil and gas like it's a sunset industry.
Right.
But the math tells a totally different story.
This highlights companies like SOB that's formerly Schlumberger, which yields around
2.5%.
The reality is that the world still needs to rebuild heavily depleted petroleum reserves.
Right.
And ironically, the massive AI data centers being built right now, they are incredibly power
hungry.
You literally cannot power the AI revolution purely on wind and solar right now.
The grid demands natural gas.
So the market is discounting energy companies as these dinosaurs, while the actual underlying
demand for their product is expanding because of AI.
Exactly.
Okay.
Let's take that house inspector analogy that load test we were talking about.
And let's apply it to the exact place the market is panicking the most right now.
The tech and services space.
Yeah.
The research highlights this group of high quality business services that are just getting
dumped by investors on fuels of AI disruption.
We're looking at paychecks, ticker PAYX, faxset, ticker FDS, and Thompson Reuters ticker TRI.
What exactly do these companies do and why is the market suddenly so terrified of them?
Well, these are companies that provide critical recurring services.
Paycheck handles payroll and HR for businesses, faxset aggregates deep financial data for
Wall Street analysts.
And Thompson Reuters provides these massive databases for legal and tax professionals.
The market narrative right now is that artificial intelligence is just going to do all of this
for free.
You know, an AI will run the payroll and AI will pull the financial models and AI will
write your legal briefs.
Therefore the market thinks these companies are essentially dead walking.
But the financial signature we see in the research completely contradicts that panic.
I mean, all three of these companies have grown their revenue for four straight fiscal
years.
Right.
Four straight years.
Right through the market drawdowns.
Right through the absolute peak of the AI hype cycle.
Their top lines kept growing, the cash kept flowing, but their stock prices just got hammered.
Which brings us back to the core lesson here.
It's down, so it's cheap.
Is not a valid investment thesis.
A stock can drop 50% and still be overpriced, you know, yeah, that's true.
We have to look at the free cash flow coverage to see if the drop is a genuine mispricing.
So let's look at Thompson Reuters TRI.
This is actually the deepest markdown of the group.
It dropped 43% from its 52 week high of $182 and 82 cents.
It's now sitting around 104 bucks a share.
That's a huge haircut and it yields roughly 2.4% now, right?
Yep.
But if you just casually pull up their stock profile on, you know, wherever, their earnings
actually look a bit lumpy.
The payout ratio on their gap earnings is 80%.
Okay.
80% feels dangerously tight.
It does.
This is exactly where we have to separate accounting rules from reality.
Gap stands for generally accepted accounting principles.
It includes non-cash charges like depreciation.
It's an accounting measure.
It is not a measure of the actual dollars hitting the company's bank account.
If we look at the actual cash, the free cash flow, the dividend only eats up 53% of the cash
they generate.
Oh, wow.
So that's a very comfortable coverage ratio of almost two times over, a 1.91X coverage
specifically.
And for those of us not looking at spreadsheets every day, the research mentions their balance
sheet is incredibly light with net debt at just half of their EBITDA, which EBITDA is essentially
the raw operating cash, the business generates before taxes and accounting tricks, right?
Right.
For interest, taxes, depreciation and amortization.
So their debt is incredibly low compared to the money they pull in.
Correct.
Their debt is practically a non-issue.
Correct.
And this is important that there is a reason the market is discounting them.
Thompson Reuters is carrying a massive capital expenditure burden right now.
Oh, massive.
They are spending over $645 million to completely rebuild their legal and tax products around
AI.
They are spending heavily today to ensure they survive the disruption tomorrow.
Ah, so they're aggressively renovating the house.
Yeah.
Okay.
Now compare that to FACSA, ticker FDS.
They're down about 27%, trading around $284.
They have the lowest yield of the three, just over 1.5%.
And their PE is about 18.8 times, but their dividend coverage is pristine.
It is the cleanest of the group by far.
The dividend consumes a mere 26% of their free cash flow.
That is an incredible coverage ratio of 3.86 times over.
They have massive breathing room.
Wow.
Okay.
Yes.
PAYX, this is the shallowest drop of the three down just 14% to about $121.
But it offers the highest yield at 3.75%.
They pay out 68% of their free cash flow.
So it's a 1.46 times coverage.
It's covered, but there is a catch hiding on the balance sheet, right?
There is.
And the catch is debt.
They have $3.47 billion in debt on the balance sheet from acquiring a company called Paycor.
Because they are carrying that debt burden, their cash cushion is the tightest of the
three.
Makes sense.
So if interest rates stay high, or if they need to suddenly pivot their business model to
fight off some AI competitor, they just have the least amount of maneuverability.
Okay.
Let me stop you there, though, because I have to push back on this entire premise.
Okay.
Go for it.
We're looking at these coverage ratios.
And we're saying, look, the cash flow is great.
They can comfortably pay the dividend today.
But if AI actually does completely disintermediate their business models in three years, like,
if a startup builds software that just bypasses fax set or paychecks entirely, isn't the market
completely right to discount them heavily right now?
Like, why catch a falling knife just because the dividend is safe this afternoon?
This raises an important question.
And it really gets to the absolute crux of the AI debate happening on Wall Street right now.
You have to separate pricing known mathematical cash flows from pricing unfalsifiable disruption
risks.
Okay.
It proves the dividends are safe today.
The balance sheets for the most part are very sound.
The cash is hitting the bank.
What the market is debating is entirely about something called terminal value.
Meaning, will the company even exist in a decade to have any value at all?
Exactly.
If you believe AI completely destroys their moat, then yes, these stocks are a total value
trap.
But if you believe these infringed companies will simply incorporate AI, like Thompson Reuters
is doing to improve their own margins and offer better products to their existing clients,
then the market has severely mispriced their future by panic selling them.
It's the ultimate staring contest with the future.
You're just betting on whether the incumbent adapts or dies.
But let's flip the script.
If the market is aggressively punishing perceived risk in tech and services, what happens when
it desperately clings to perceived safety in consumer staples?
Because that creates a completely different kind of mispricing, which is the overvaluation
trap.
We see this crystal clear in the research with Coca-Cola, ticker K0.
When investors got scared of tech volatility, they just flocked to Coke for safety.
Shares surge 25% to an all-time high of $86.87.
But when you strip away the warm fuzzy feeling of owning this classic brand and look at the
math, it's actually kind of startling.
You are paying 26 times earnings for a stock that has a compressed yield of about 2.39%
and is only expected to generate a modest 5% organic growth.
So what does this all mean?
Let's translate that 26 multiple into plain English for you listening.
You are paying $26 up front for every $1 profit the company makes.
That is a premium price tag you usually reserve for a fast growing tech company, not a soda
company growing at 5%.
It feels like investors are paying a massive luxury tax on Coca-Cola just to sleep at night.
The analyst in our research argues exactly that.
A 5% to 6% grower simply does not justify a 26 times premium multiple.
The underlying business of Coca-Cola is fundamentally sound, of course, people get to keep buying soda.
But the valuation is completely stretched.
The stock price has entirely decoupled from the actual cash flow growth you are overpaying
for safety.
While some investors are hiding in Coca-Cola, others are just chasing the shiny object of
sudden momentum.
The research highlights target, ticker, TGT.
They have been executing this turnaround under their new CEO, Michael Fidduck.
The stock is up 53% year to date, sitting around $152.
It is a 55 year dividend king yielding 3%.
This quarter net sales jumped 6.7%, I mean, on paper, it looks like a massive win.
It looks like a win, but the bare case in the research points out a huge psychological trap
here.
After a stock runs up 53%, you start seeing a flood of analyst upgrades.
Of course, everyone wants to be on the winning team.
Exactly.
But you have to ask, is Wall Street showing genuine conviction in the underlying business turnaround?
Or are they just chasing the momentum?
The easy money on the turnaround has likely already been made, buying in after a massive
spike elevates your valuation risk significantly.
You're just buying the green arrows, hoping for more green arrows rather than buying the fundamentals.
Which brings us to the absolute most dangerous part of our deep dive today.
If safe equities like Coca-Cola are way too expensive and cheap equities like FACSET carry all
this terrifying AI baggage, yield starved investors often just throw their hands up and look
to alternative funds.
And this is where the market mispricing turns predatory, and the confusion between a real
yield and a manufactured one.
Yes.
This is a critical distinction that destroys so many retirement portfolios.
Let's look at what a real mathematically covered yield looks like first.
The research points to a closed and fund called the PIMCO Dynamic Income Strategy Fund, ticker
PDX.
Okay.
Let's unpack PDX.
The yield a massive 7.5% on its discounted market price, about 6.8% on NAV.
And over five years, it returned 24.4% annualized.
Which is fantastic.
It is.
But crucially, it's trading at an 8.8% discount to its net asset value.
What is net asset value or NAV?
And why does that discount matter?
Net asset value is simply the total value of all the actual investments held inside the fund,
minus any liabilities, divided by the number of shares.
Okay.
The stuff inside is actually worth if you liquidated it today.
Because of how closed end funds trade, you can sometimes buy them for less than their NAV.
You are literally buying a dollar's worth of assets for about 91 cents.
It's a great deal.
It is.
But more importantly, let's look at why that 7.5% yield is real.
PDX invests in high yield corporate bonds.
Right now, the underlying high yield bonds in that portfolio are generating about 7.2%
in actual interest.
Okay.
But what about the risk of those companies going bankrupt and not paying the bond?
Historically, corporate default rates have only averaged about 2.5%.
So the cash coming into the fund from the interest on the bonds actually covers the distribution
going out to the investors.
The math works.
The underlying assets are generating the income.
Okay.
Now, let's look at the dark side, the manufactured yield.
The research analyzed a family of 7 funds run by a provider called Nicholas Wealth known
as their X funds.
Their marketing pitch sounds like a dream.
Honestly, they promise a steady yield that sits right in the middle ground between zero yield
text stocks and super-resty ultra-high yield bonds.
If we connect this to the bigger picture, this family of funds is the living, breathing
embodiment of manufactured yield.
Plus all 7 of these funds, they boast a massive 18.4% average yield.
18%.
I mean, if you are staring at a screen trying to generate income for retirement, that feels
like you just solved the entire puzzle.
Until you look at the principle, since their inception, these funds have hidden a devastating
negative 22.74% average capital loss.
Ouch.
Yeah.
When you combine the massive yield, they page you with the massive loss in your initial investment.
These are actually netting a total return of negative 4.34%.
Let's isolate one specific fund to make the mechanics of this real.
They have a global equity and income fund, ticker G-I-A-X.
It flashes a 22.05% current yield, but it is paired with a negative 19.32% capital loss.
How does a fund legally pay out 22% while losing money?
Because they are manufacturing the yield.
The underlying assets in these funds, whether it's crypto, metals, or nuclear stocks, they
are not generating anywhere near enough actual cash flow to support a 22% payout.
So where does money come from?
To make the payment, the fund simply sells off its own assets.
They deplete their own net asset value.
They're essentially taking your own investment principle, slicing a piece off, handing it back
to you, and calling it income.
Buying a fund with an 18% yield that loses 22% of its principle is literally like cutting
slices off your own leg to feed yourself, and then bragging to your friends about the
amazing all-you-can-eat buffet you found.
It really is.
It is an absolute illusion.
I mean, you feel rich every quarter when the payout hits, but you are bleeding to death
on the balance sheet.
Your initial investment is shrinking, which means next year's yield is paid out on a smaller
base, which means your wealth is just evaporating.
That is a graphic analogy, but it is mechanically, perfectly accurate, and it ties everything
we've talked about today together.
This pricing, whether it's a stock or a fund, happens when you stop looking at the underlying
mechanisms of cash generation and just look at the surface numbers.
Let's bring this home-free listening.
If you are managing your own portfolio, the fundamental lesson of this deep dive is this.
Real yield is funded by free cash flow.
Manufactured yield is funded by your own capital, whether you are looking at AI panic markdowns
like faxet where the cash flow is actually stellar despite the stock dropping, or you are
looking at a premium blue chip like Coca-Cola, where the valuation is completely detached
from reality, or you are getting lured in by an 18% fund trap, oh, wait, excuse me.
Getting lured in by an 18% fund trap, the cash flow statement is the ultimate lie detector.
It tells you if the foundation of the house is solid, or if it's just a fresh coated paint
over rotting wood.
And that leads to something I've been thinking about as we reviewed these sources.
What's that?
In a market completely obsessed with how AI is going to disrupt the future, maybe the
biggest disruption to an investor's portfolio isn't technological at all.
Really?
Yeah, maybe it's a simple, timeless math of capital allocation, punishing those who forget
how cash flow actually works.
That is a fascinating thought to leave on.
The structural low-test always comes due, whether it's tomorrow or in 10 years.
Thank you so much for joining us on this deep dive into market mispricing.
Keep your eyes on the free cash flow, demand real yield, and we will catch you next time.