Ep. 134: Beyond the AI Trade — Where Dividend Money Is Actually Working in 2026

You know, if you were to just glance at the headline financial news this year in
2026, you'd probably think we're living in a completely one industry world.
Oh, absolutely.
Everything is AI this artificial intelligence that right.
It feels a bit like being at a really crowded house party, where absolutely
everyone is crammed into the living room.
Just, you know, huddled around this flashy, incredibly expensive AI ice
sculpture.
It's mesmerizing.
Honestly, it takes a ball the oxygen in the room and nobody wants to look away
just in case it does something spectacular.
Exactly.
But while everyone is hypnotized by that living room, they are completely
ignoring the absolute feast of durable compounding returns.
That's just sitting totally untouched in the kitchen.
Yeah.
The rest of the house is wide open wide open.
And that is exactly our mission for this deep dive today.
So we're digging through a massive stack of Q2 earnings reports, algorithm
trading data, passive flow charts.
You name it lots of data today, lots of data.
But the goal is to look beyond the AI trade and map out where dividend money
is actually working right now for you.
Because underneath the hood of what looks like a dangerously top heavy market,
there's a quieter, highly profitable rotation happening.
Yeah.
And to understand why that dividend money is working so well right now, we
really first have to expose the optical illusion of what's happening with those
headline market indexes.
The S&P 500 specifically, exactly.
The S&P 500 is historically concentrated right now.
We're looking at a scenario where roughly 38% of the entire index
sits in just 10 mega cap names, 38% Wow.
So if you think you're buying a diversified basket of 500 companies,
you're actually just placing a massive bet on a handful of tech giants.
Right.
You're buying tech with a tiny side of everything else.
And that concentration creates a total mirage when it comes to the numbers,
the broader market actually reports.
How so?
Well, take the second quarter of this year, the headline S&P 500 earnings growth
was reported at a staggering 47%, which sounds phenomenal.
I mean, 47% growth across 500 companies is, you know, it's the kind of
number that makes you want to mortgage your house and just buy index funds.
Right.
It does until you look at the accounting.
Ah, there's always a catch.
Always that 47% is heavily inflated by non operating investment gains
from literally just a couple of those mega caps really.
Like who specifically massive markups on the investment portfolios
at Amazon and alphabet.
So when you strip out those paper gains and just look at the actual operating
earnings of the companies, you know, the money they make from their actual businesses.
Right.
The stuff that matters exactly that 47% headline growth drops to closer to 28%.
Okay.
Let's unpack this for a second.
The top line number you see on the news is basically being skewed by a few tech
giants, essentially greeting their own investment homework.
Yeah.
That's a good way to put it.
But the actual business operations, the market,
they're growing, but in a much more grounded rate, that's the reality.
And it's precisely why we're seeing this quiet rotation underneath the surface.
Deep value and high dividend strategies have actually built a 10% performance
lead over the cap weighted growth benchmarks in 2026.
So if you're listening to this, you might be thinking, you know, I've already missed
the boat.
I mean, if value has already swung that hard and built a 10% lead year to date,
are we just talking about a trend that's already winding down?
No, not at all.
The data suggests the runway is still incredibly long here.
And it really comes down to the valuation gap, the multiple gap, right?
Even after that big performance swing toward value, the multiple gap is still massive.
So right now growth stocks are trading at roughly 43 times their trailing earnings.
Okay.
While value stocks are sitting at about 24 times.
So let's ground those numbers for everyone.
You're looking at a 19.5 turn difference in the multiple.
And for anyone trying to visualize that, a turn is just one point on that price
to earnings ratio.
Right.
So we're talking about a gap of almost 24 points.
And that gap is historically huge.
It tells us that this 10% outperformance hasn't even come close to closing the valuation
chasm.
Wow.
Yeah, for every dollar of profit, a value company makes you paying $24.
For a growth company, you're paying $43.
That's a huge premium.
It is that the rotation has barely started to bridge that divide.
And what's crucial is that this shift is backed by real broad economic fundamentals.
Like in that same second quarter, 10 out of the 11 market sectors delivered positive earnings
growth.
10 out of 11.
Yep.
And eight of them were in the double digits.
Revenue was up 14% year over year.
So the wealth is actually spreading out finally.
Yeah.
And to capture that broadening without taking on the concentration risk of say a traditional index
fund, our sources point to sector balance dividend strategies.
Right. They highlight a specific one.
Yeah, the ALPS sector dividend dogs ETF ticker is SDOG.
Let's talk about that.
So SDOG uses an equal weighted approach.
It takes 10 S&T 500 sectors.
It excludes real estate, by the way.
And it gives them a flat 10% allocation each.
Okay.
So totally back exactly.
And within each sector, it holds the five highest yielding stocks that gives you 50 names
total and it rebalances quarterly.
I want to pause on that quarterly rebalancing thing because that's the mechanical secret
sauce here, right?
It really is because in a normal S&P 500 fund, since it's market cap weighted, every time
a tech stock goes up, you automatically own more of it, which just inflates your risk.
Right.
You're buying more of what's already expensive.
But as DOG physically forces the fund to sell what's expensive and buy what's cheap every
single quarter, just to maintain that flat 10% across the board.
Exactly.
It mathematically prevents any single sector from dominating the portfolio.
You're forcing a discipline of buying low and selling high across 10 distinct sectors,
which is so hard to do manually.
It's basically impossible for most people, but this ensures you genuinely capture that broad
value rotation rather than just writing the coattails of whatever is currently popular.
It's a structural way to protect yourself from your own biases because when we look at
the specific companies driving this 10% value lead, they aren't the flashy startups.
We're talking about the dividend aristocrats.
Yeah.
So to be a dividend aristocrat, a company has to be in the S&P 500, meet certain liquidity
requirements.
And most importantly, they must have raised their dividend payout for at least 25 consecutive
years, which is wild if you think about it.
That means they were raising dividends through the dot-com bust, the 2008 financial crisis,
the 2020 pandemic.
They don't care what the market is doing.
Exactly.
They just keep methodically hiking the payout.
And while the S&P 500 is up a very solid 12.6% this year, these boring conservative aristocrats
are quietly crushing it on a total return basis.
They really are.
You get Exxon Mobile, ticker XOM, up about 37% in 2026, Coca-Cola, ticker K-O, up 31.58%
and Caterpillar, ticker C-A-T, is up 36.46%.
And you know, the composition of these winners tells a very specific story.
We're looking at heavy cyclicals, energy, consumer staples.
Bread and butter stuff.
Exactly.
These are classic businesses that hold up in a correction.
They aren't promising to change the world with a new algorithm.
They are just relentlessly executing their core operations.
Wait, okay, I have to challenge this though, especially looking at Caterpillar.
Because it's up over 36%, right?
Yeah.
But it pays a tiny 0.76% dividend yield.
Sure.
Why on earth would a dividend investor buy a stock yielding less than 1%, like, isn't that
just a cyclical growth stock wearing a fake dividend mustache?
It's a fair question, and that's how a lot of casual investors view it.
But sophisticated capital allocators, they view dividends differently.
A dividend isn't just a paycheck for them.
It's a signaling mechanism.
Okay.
What do you mean by that?
Well, when a cyclical, highly capital intensive company like Caterpillar commits to raising
its dividend for over 25 years, it proves that its underlying cash flow is resilient enough
to survive severe economic downturn.
Oh, I see.
So the yield is only small today because the actual stock prices run up so rapidly.
But the fact that the dividend simply exists and grows is the board of directors basically
stamping a seal of approval on the underlying health of the business.
Right.
A board is not going to commit to a 25-year streak of dividend hikes if they think their cash
flow is a house of cards.
They look ridiculous.
Exactly.
Investors are rewarding businesses that deliver operational certainty.
They're looking past the pure yield and they're buying the assurance that these companies
know how to generate cold, hard cash in literally any economic weather.
There's a massive piece of the puzzle we're missing here, though.
What's that?
Why are old school industrial names like Caterpillar or energy names for that matter, doing so incredibly
well in a year completely dominated by AI?
Uh, yeah.
That's because the AI trade is literally spilling out of the digital realm and crashing into the
physical world.
That's spilling over.
Yes.
Artificial intelligence doesn't just live in the cloud.
The cloud is a physical place.
It's a hyperscaler data center that spans multiple football fields.
And those data centers require massive physical resources.
Like land, heavy construction equipment, which explains Caterpillar, uh, physical networking
gear, and above all, immense amounts of electricity and cooling.
Exactly.
The capital expenditures to build this out are just astronomical right now.
This physical spillover is so massive that AI related debt now makes up roughly 15% of
the entire US investment grade market.
Wait, 15% that is wild.
It's huge.
And that money is flowing directly into utilities, industrials and materials.
It's like the ultimate pick and shovel play, you know, during a gold rush, you don't necessarily
buy the prospectors, hoping to strike it rich.
You buy the company selling the pickaxes.
Exactly.
And today the pickaxes are the companies pumping the cooling water or, you know, hauling
away the data center trash.
That dynamic is giving rise to a strategy the sources highlight for DIY investors.
They call it the core and satellite portfolio approach.
Let's break that down.
So you hold a core of broad, high quality index funds.
And then you use satellite positions to target companies providing this physical AI infrastructure.
Investors are specifically targeting what they call dividend contenders.
These are companies with 10 to 24 years of dividend hikes that offer what we might call
anti-AI disruption defense and a disruption.
So businesses that a language model can literally never replace.
Exactly.
Look at waste management, ticker WM, right?
You cannot write code to physically haul away garbage.
At least not yet.
Right.
Exactly.
Or look at American waterworks, ticker AWHK.
It's a regulated utility providing water to 14 million customers across 14 states.
Or a Lockheed Martin ticker LMT, where 73% of their revenue comes directly from the
US government.
Wow.
These are businesses with incredibly wide physical or regulatory modes.
But if everyone knows AI needs water and trash removal, these stocks can't be cheap, right?
Uh, no.
They aren't.
Because these premium defensive businesses are so resilient, the market has aggressively
bid them up.
Waste management is currently trading at a blended PE of 28.5 times.
Oh, wow.
Yeah.
And American waterworks is trading at 23 times.
For utility and a garbage collection company, those are historically very expensive multiples.
So if you're an investor looking at these bulletproof, but expensive companies, what's the
actual move?
You obviously don't just dump all your cash in at once at a 28 times multiple.
Right.
The sources suggest a much more measured approach to mitigate that valuation risk.
One method is simple dollar cost averaging, you know, buying small, set amount steadily
over time to smooth out your entry price.
Standard advice.
Some investors use options, specifically writing cash secured puts.
Okay.
Let's break down cash secured puts because for a lot of people that sound super intimidating.
Sure.
Essentially, you agree to buy the stock.
If it drops to a specific price, you actually want to pay.
And the market pays you a cash premium right now just for making that promise.
Basically, yeah.
You're getting paid to wait for a bargain.
If the stock never drops to your price, you just keep the premium.
Nice.
If you drop, you buy a company you already wanted a devaluation you're comfortable with.
It's a very strategic way to handle premium, undistreptable companies that are currently
overvalued.
Okay.
So we're seeing these physical AI infrastructure stocks get historically expensive.
So we want to avoid overpaying for utilities or garbage collection.
We have to look for companies.
The algorithms are actively mispricing rights.
Exactly.
Where is the genuinely cheap quality hiding right now?
Well, it's in the assets, the market has completely misunderstood due to how algorithm
screen data.
And there is literally no better example in our sources than the single stock case study
on Colgate-Paul Molliv, ticker CL.
Colgate.
I mean, that is a classic dividend king.
They paid a dividend every single year since 1895.
Incredible streak.
But looking at the nudge in the report, their trailing PE ratio is sitting at a nosebleed
36.7 times.
I mean, that looks significantly more expensive than waste management.
It does look that way, but that is exactly where the market's quantitative algorithms
are making a massive mistake.
Oh, Lord, yeah.
You have to look at why that PE is so high.
Colgate's JAPnet income, the standard accounting profit that shows up on the headline, it dropped
from $2.89 billion down to $2.13 billion.
So the algorithms see falling earnings in a spiking PE ratio, and they blindly hit the cell
button.
But why did the income drop?
Drop was caused by $794 million non-cash impairment cards related to weakness in their
skin health business over in China.
Hold on non-cash, meaning they didn't actually lose $794 million out of their bank account.
Nope.
It is purely an accounting adjustment.
They essentially had to write down the value of a past acquisition on paper to reflect that
it wasn't worth what they originally paid for it.
Interesting.
While the accounting profit collapsed, their free cash flow held.
The actual tangible cash piling up in their bank account that rose from $3.55 billion to $3.63
billion.
Wait, really?
The algorithm saw a JAP earnings drop on paper and dumped the stock, even though the actual
cash the business generated went up.
That's exactly what happened.
That feels like a massive blind spot.
It is.
And it's a blind spot exacerbated by a market heavily driven by passive flows and quantitative
algorithms that only screen for headline PE ratios.
Because when you strip away that one-time paper charge, Colgate's forward multiple drops
to a much more reasonable 23.5 times.
Which puts it right back in line with that value rotation average we talked about earlier.
Exactly.
The sources point out that Colgate currently has an enterprise value free cash flow yield
of 4.5%.
Let's translate that real quick.
If you look at the total price tag of the entire business, including all of its debt,
and compared to the actual cash it puts in the bank, it's generating a 4.5% yield.
That's real cash, not an accounting trick.
Right.
Their massive $3.63 billion in free cash flow covers their dividend almost two times over.
They have gross margins above 60%.
Wow.
It's a wildly profitable business that is fundamentally healthy, but it's left on the discount
rack simply because the crowd is chasing AI and the algorithms misread an accounting
rule.
Finding these non-cash accounting anomalies is such a great way to exploit the machines.
But is this mispricing isolated to just single stocks like Colgate?
Or are there broader macro bargains out there?
Oh, the same dynamic of extreme divergence is absolutely playing out on a global scale.
The gap between US large cap stocks and international stocks right now is staggering.
Hosts staggering.
While over the last 15 years the Vanguard S&P 500 ETF, ticker VOO, gained 781%.
The Vanguard total international stock ETF, ticker VXUS, gained only 212%.
So the US market has just utterly dominated the last decade and a half.
It has.
But that dominance stretches valuations to the breaking point.
Right now, VOO trades at roughly 20 times forward earnings.
VXUS, the international fund, sits at a substantial discount of about 15 times forward
earnings.
Okay, that's a big gap.
And Vanguard's own capital markets forecast actually expects a reversal over the next decade.
They project US stocks to return 4.2% to 6.2% annualized, while they expect developed international
stocks to pull ahead with 4.5% to 6.5% annualized returns.
So why does Vanguard expect international to suddenly win out after literally 15 years of
lagging?
Obviously, but it's also structural.
The US market is heavily concentrated in technology which we established up top.
International markets skew much heavier towards cyclical sectors like financials and industrials,
which are the exact sectors benefiting from this broad value rotation right now.
Furthermore, Vanguard expects a weaker US dollar over the next decade.
Let's explain why a weaker dollar actually helps you if you own international stocks.
Yeah, so when you buy an international stock, that company is doing business and making
profits in euros or yen or pounds.
If the US dollar weakens, the money those international companies make in their local currencies
translates back into more US dollars for you as an investor.
Ah, I see.
Yeah, it acts as a mechanical tailwind for your returns.
Okay, but before you go and sell all your US tech stocks to buy international cyclicals and
misunderstood toothpaste companies, we definitely need to inject a heavy dose of reality
here.
Always a good idea.
Trying to perfectly time a market rotation is like trying to jump from one moving train
to another.
If you miss, it's going to hurt.
It will.
We have to be brutally honest about the two-sided risks here.
The most obvious risk is that market rotations can abruptly reverse.
What's working today might not work next month.
Frankly, stock picking is inherently difficult, even when you spot a glaring algorithmic
mispricing.
Even with that Colgate example, right?
Because the cash flow story is amazing.
But over the trailing year, the broad Schwab US dividend equity ETF ticker SCHD, it actually
returned about 30% while the single Colgate name only returned 12%.
Exactly.
The broad dividend index outran the individual stock pick because the case for Colgate
really rests on its forward-looking cash economics over the long term, not some short-term
catalyst.
We also have to warn against value traps, just because the stock has a low PE ratio doesn't
mean it's a bargain.
Sometimes the stock is cheap because the underlying business is genuinely deteriorating.
Right.
Like, look at Kroger, ticker KR.
It looks like an absolute steel at an 11 times PE ratio yielding almost 3%.
But retail is a highly cyclical industry.
We've seen significant slowdowns in the retail sector recently, with consumers really feeling
the pinch of inflation.
Yep.
People are buying less.
Exactly.
So the market might be assigning Kroger that low 11 times multiple because it correctly anticipates
a slowdown in their business model.
It's not an algorithmic misunderstanding in that case, it's a warning label.
And this leads to arguably the most important takeaway regarding valuation from all of these
sources.
Valuation is a tool for predicting decades, not days.
A 19.5 turn valuation gap between growth and value.
Or a 5 point PE discount on international stocks, that tells you about the potential return of
those assets over the next 10 years.
Right.
It tells you the destination, but it tells you absolutely nothing about what the stock is
going to do next Tuesday.
The conclusion of all this data isn't to dump your US growth engine, your VOO, and replace
it entirely with your international value, your VXUS.
The conclusion is that you need to hold both as complementary assets.
Right.
You don't decouple from the US growth engine.
You just add some international and dividend shock absorbers to your portfolio to navigate
the rotation.
Because durable compounding wealth is often found exactly where the crowd isn't looking.
It really is about looking past the headline mirage and finding the companies that are quietly
funding the infrastructure of the future, or generating massive free cash flow while the
algorithms are distracted.
So when you look at your own portfolio today, think about the blind spots we've uncovered
here.
If a massive, non-cash accounting charge can completely hide the underlying cash strength of a household
name like Colgate from the broader market.
What other perfectly healthy cash printing companies are currently being dumped by algorithms just
because they didn't mention the word AI on their latest earnings call.
That is the multi-million dollar question every investor should be asking right now.
We'll leave you to dig into that until next time.