Ep. 154: SCHD Is Not a Bond — Our Crash Test, Nvidia's 2,400% Dividend Hike & Undervalued Utilities

you know, usually when we talk about something like a medical diagnosis, there's this comforting
expectation of precision, right? Right. You want black and white answers. Exactly. Like,
you break your arm, the x-ray shows this jagged white line and the doctor just points to the
screen. It's visible. It's neatly categorized. Yeah, there's no ambiguity. But the second you step
into the world of dividend and income investing to try and, you know, build a portfolio for yourself,
I mean, that x-ray machine just shattered. That's a cool, eatly breaks down. It really does. We're
looking at a financial landscape today that is just entirely murky. Like, you'll see a fund yielding
12% and the traditional financial x-ray says, well, that must be a trap. Right, the old, if it's too
good to be true. Yeah. Or you see a century old utility stock and the x-ray says it's perfectly safe.
But the deeper you look into the actual mechanics of these assets, the more those old rules just
completely fall apart. You do because in a financial world that's, frankly, completely obsessed
with headline yields. Yeah. You know, chasing the absolute biggest percentage pay out you can find.
Oh, totally. Everyone just wants the highest number. Right. But the single most critical metric for your
long-term survival is actually total return. I mean, yield is just one piece of the math. So it's not
just about the cash they hand you every month. Not at all. To build lasting wealth, it really comes down
to understanding the underlying mechanics of an asset and knowing exactly what specific job
tool is hired to do in your portfolio. Well, we have a massive stack of research to get through today
on exactly that. And I want to start by testing the probably the most popular narrative in the income
space right now. Well, I know this is going. Yeah. I mean, there is this massive, incredibly loyal
following for the Schwab US dividend equity ETF ticker SCHD. It's basically a religion for some
investors at this point. It really is. And the argument you hear everywhere is that because SCHD holds,
you know, 100 high quality dividend paying companies, it naturally has lower volatility. Right.
The idea that blue chip means inherently safe. Exactly. So the theory goes, you can use it to replace
the boring low yielding bonds in your portfolio. Like people are calling it their safety sleeve. Yeah.
And I mean, that's a very tempting pitch, right? Especially for anyone who's just tired of negligible
bond return. Totally. Why take 4% when you can get dividend growth? Exactly. The idea is that
SHD swings less violently than the S&P 500. It pays this steadily growing dividend. And so it feels
like a safer place to park your cash. But, and this is key, we really need to define what a safety sleeve
actually means mechanically. Okay. So what does the math say it should be? Well, a safety net really
has two non-negotiable jobs. Job one is simply holding its value during a catastrophic market crash.
Right. Just don't lose my money. Yeah. And job two, which is honestly the critical function most people
completely ignore is that it has to act as your liquidity. Like cash on hand. Exactly. It has to
be the asset you can sell to pay your mortgage or your living expenses. Yeah. So that you're never
forced to sell your course stock positions at the absolute bottom of a bear market. And that
second job is where this whole SHD theory just hits a brick wall. A massive brick wall.
Because the informed investing crash tests in our source material, they didn't look at theoretical
projections. They looked at actual historical data. Right. What actually happened when the panic hit?
Yeah. So let's look at the COVID crash. Specifically that window from February 19th to March 23rd, 2020,
which was the fastest bear market in history is terrifying. It was. And if you had parked your
emergency cash or your bond allocation in SHD, you were in for a brutal shock. I mean, SHD plummeted
32.8%. Wow. Yeah. And the broader S&P 500 fell 34.0%. Which basically means it offered virtually
zero protection. But wait, a 32% drop. I mean, the whole selling point of SHD is that it screens for
these blue chip cash cows companies with rock solid balance sheets. Supposedly the safest stocks
you can own. Right. So why did it drop almost identically to a broad market index full of, you know,
risky tech stocks? Well, because in a true liquidity crisis, correlation just goes to one.
Meaning everything moves together. Exactly. When panic sets in and margin calls start hitting
institutional investors just sell whatever they can. Not what they want to. They just need cash
immediately. Right. So the underlying fundamentals of the companies inside SHD, they honestly
didn't matter in March 2020. There were equities and all equities were being liquidated. Wow. Okay,
so what about the alternatives then? Well, look at how the traditional safe havens performed.
If you held the Vanguard total bond market fund to your BND, you actually finished that volatile
five week window nearly flat. Okay. So bonds did exactly what they were supposed to do. Not
perfectly. And this is where the mechanics really matter again. Because even a massive,
highly diversified bond fund had a terrifying moment in there. Wait, really? Even BND? Yeah.
During the worst single week in mid March, there was this severe liquidity crunch in the credit
market. It's like nobody wanted to bite dead at all. Oh, I remember that. The whole system just
seized up exactly. And that caused BND to drop 8.7% very suddenly. Yeah. So think about it. If
you're living expenses came due that exact week and you had to sell your BND shares, even the
supposed safe haven of bonds actually hurt your portfolio. Which brings us to the only asset
last in the research that actually executed both jobs flawlessly. Right. Short term T bills. Yeah.
Funds holding treasury bills that mature in just one to three months, things like SGV or BIL.
They held entirely study through the entire COVID crash, no stress, no drop. And we see that
identical pattern play out in the late 2018 market sell off too. Right. The data shows the
S&P 500 fell 19.5% then and SCHD fell 17.1%. So again, almost no cushion at all. None. While bonds
and T bills, meanwhile held steady or actually went up. And if we look even further back to
a proxy for the 2008 financial crisis, since STHD didn't exist yet, similar high dividend funds
like DVY plunged 62.6%. 62%. Yeah. Because the label dividend does not offer some magical protection
from a crash. In 2008, the financial institutions paying the highest dividends were the very
companies going bankrupt. So using an equity fund like SCHD as your emergency safety net is essentially
like, well, it's like installing an airbag in your car that only inflates after the ambulance
arrives. That's a great way to put it. Right. I mean, yes, SCHD recovered beautifully by the end
of 2020. It's a world class compounding machine over the long term. Absolutely. No one is denying
it's a great fund. But if you're a retiree who needed say $40,000 in March of 2020 to live on
and you sold SCHD, you locked in a permanent massive loss. The airbag failed at the exact
moment of impact because the timing of liquidity is everything. Right. But you know, we also really have
to address the 2022 rate shock because that is the year that convinced so many people that
SHD could replace bonds. Oh, right. Because if you look at the 2022 data, people say, well, SHD only
fell 3.2% while the total bond fund BND fell 13.1%. Exactly. So it looks on paper like SHD was the
safer asset. It totally does. So what's the catch on paper? Sure. But mechanically, why did bonds fall
in 2022? It was duration risks, meaning interest rates going up. Right. When central banks spike interest
rates at a historic pace, newly issued bonds pay a much higher yield. That immediately makes older
existing bonds less valuable, which crushes their price. And BND holds longer term bonds. Exactly. BND
holds intermediate and long term bonds. So it's suffered massive duration risk. But T bills,
because they mature in mere weeks, have almost zero duration risk. They just roll over into the new
higher rates, which is why T bills actually ended 2022 up 1.4%. Wow. And SHD didn't act as a bond
in 2022 either. It just happened to be a highly concentrated value stock fund in a year where value
stocks violently outperformed growth stocks. Okay. So the takeaway from all this crash data is pretty
definitive. SHD is a phenomenal wealth building tool, but it is fundamentally a stock fund. It is not
a bond or cash replacement period. It comes back to aligning the tool with your specific timeline,
like equities are for decades. T bills are for tomorrow. Exactly. So if SHD isn't a safety net,
we have to evaluate it on its actual day job, right? Which is paying and growing dividends.
Let's look at the numbers. Yeah, because we just got the Q3 2026 dividend announcement for
SHG. The payout is $1.2665 per share. Right. Which is just a 2.3% increase from last September.
And this highlights the danger of static projections. We're here. Well, so many investors just plug
this automatic like 10% annual dividend growth rate into their spreadsheets. They assume a fund will
just compound endlessly at that speed because it did it in the past. Right. But an ETF is just a rapper.
It's dividend can only grow mathematically as fast as the underlying 100 companies inside the portfolio
are raising their own individual payouts. So if their growth slows down, the fund slows down.
Exactly. When corporate earnings growth slows, the fund's dividend growth slows right along with it.
Which honestly makes the broader dividend landscape right now so strange because if you look at where
the growth actually is, I mean, look at Nvidia. I have videos fascinating right now. It's wild. The
absolute epicenter of the AI hardware boom just announced a 2400% dividend hike. The massive shift.
They took their quarterly payout from one penny up to 25 cents. And the absolute dollars involved
there are just staggering. I mean, they are returning roughly 25 billion dollars to shareholders
this year. Individends alone. And they're pairing that with what an 80 billion dollar share buyback.
Yeah. Now because Nvidia stock price is appreciated so massively, the actual dividend yield on the stock
is still just a fraction of 1%. Right. It's tiny if you look at the percentage. Exactly. But the
cashflow generation is truly historic. But isn't that weird? I mean, a hyper growth tech company
deciding to pay a massive dividend. It feels like a startup suddenly acting like a retirement home.
That's a funny way to look at it. But yeah, usually companies in a hyper growth phase burn every
single cent they have on R&D or acquiring competitors, right? Why are they flushing cash out to
shareholders? It's a function of pure capital allocation mechanics. Okay. Break that down.
Nvidia is generating cash from AI chips at a velocity that just defies precedent.
They literally cannot hire engineers fast enough or build data centers fast enough
to reinvest all of those billions internally. They just have too much money. Pretty much.
When a company's free cashflow vastly exceeds its capacity to efficiently reinvest it,
the only logical move is to return it to the owners. And this dynamic actually explains a very rare
anomaly in the 2026 market. The Morningstar US dividend growth index is currently running neck
and neck with the broader market. Wait, really? Because normally when the market is ripping higher in a
massive bull run, safe defensive dividend stocks get left completely in the dust.
Precisely. But the underlying mechanics of this market are broadening out. It's not just the AI
giants driving us. Who else is doing it? Well, energy titans like Exxon Noble and Conoco Philips are
aggressively raising payouts and massive healthcare conglomerates like Johnson and Johnson,
Merck and United Health. They're generating massive free cashflow too. So it's coming from everywhere.
Yeah. You have this unique macro economic moment where value sectors, energy, healthcare and cash
rich tech are collectively pushing dividend growth indexes higher at the exact same time. Okay,
but if these mega cap tech and energy companies are dominating the dividend growth indexes now,
what is happening to the companies we actually rely on for traditional income?
You mean the boring sectors? Yeah, exactly. The boring stuff. Well, let's look at utilities.
Our research dies into a valuation framework called dividend yield theory to see if these neglected
sectors are hiding bargains. Dividend yield theory is a really pragmatic lens. It basically relies on
the principle of mean reversion, which means things eventually go back to average. Right. The mechanical
assumption is that a mature, highly regulated company like a utility will generally trade at a very
consistent, predictable dividend yield over decades. Because their business doesn't really change much.
Exactly. So if that stocks current yield suddenly spikes significantly higher than its five year
historical average, it mathematically implies the stock prices drop and the asset might be fundamentally
undervalued. Okay, so applying that theory, the research flagged five specific utility stocks
projecting four returns above 10%. Let's hear the numbers. All right, first is MGE energy,
ticker MGE. It's currently yielding 2.8%, but its five year average is only 2.2%. So that
implies that 22% discount per fair value. Exactly. And we see the same pattern across the board. Next
era energy ticker NEE is yielding 3.15% versus a historical 2.64%. Right. American water works,
ticker AWK, is yielding 2.68% compared to an average of 2.11%. CMS energy ticker CMS is sitting
at a 13% discount to its historical yield. It's remarkably consistent across the sector. Yeah.
And finally, middle sex water company ticker MSEX, which actually has a track record of raising
dividends for over half a century, is yielding 2.62% versus its 1.99% average. Those are substantial
statistical deviations, especially for companies that operate as heavily regulated monopolies with
incredibly predictable revenue strengths. True. But and I have to push back here, relying
strictly on a historical yield average, it feels kind of like checking your house's thermostat to see
why you were cold. Well, it tells you the temperature is lower than normal, but it doesn't diagnose
the actual problem. Like a high yield could mean the market has irrationally priced the stock,
or it could mean the company is drowning in debt, their earnings are collapsing, and a massive dividend
cut is about to smash through the window. No, you're absolutely right. That is exactly
the critical thinking required here. You can never deploy capital based on yield in a vacuum.
You have to look under the hood. You have to verify the underlying structural health of the business.
For utilities, the primary diagnostic check is the payout ratio. Right. Which is the exact
percentage of net earnings a company is paying out to cover that dividend. Exactly. So if we look at next
year energy, their payout ratio temporarily spiked during 2020, but the current data shows is contracted
back down to 53%, meaning they're only using roughly half their profits to pay the dividend. Yes,
the rest is retained for infrastructure investments or debt reduction. So the dividend is supported
by real growing earnings. The window is not smashed. Okay, that's a three percent utility yield is
fantastic. If you have a multi decade horizon to just let the dividends compound. Sure. If you have
the time, but the reality is a massive segment of the investing population is hunting for double
digit cash flow today. Like they need yield to pay for their lives right now. And that's where things
get dangerous. Very. Which forces us to examine the most complex highly engineered section of our
research, the funds yielding between nine and 13%. Right. This is the exact territory where investors
must ruthlessly apply that total return framework we talked about because it's whole of traps.
The high yield space is heavily populated with value traps. Yes. But there are also highly
sophisticated vehicles explicitly designed to solve the income dilemma. The private credit sector
is a perfect example of this tension. Like our sources highlight blue owl capital ticker OWL yielding
over 9%. A very popular name right now. Yeah. And their business developing company blue owl tech
finance ticker F, which is yielding an incredible 13.63%. Which turns a lot of heads. Obviously. But the
detail that jumps off the page is that ticker F is currently trading at a near 40% discount to its net
asset value. Right. I mean, how is it mechanically possible to buy a dollar's worth of underlying loans
for 60 cents on the open market? Well, a discount that steep is really the market's way of expressing
profound terror. Terror over what? Okay. So business development companies or BDCs provide private loans
to middle market companies. Blue owl tech finance specifically loans money to legacy software companies.
Okay. The prevailing narrative driving that 40% discount is the fear of AI disruption.
The market is basically assuming that artificial intelligence is going to decimate these older
software businesses so rapidly that they will default on all their loans. So investors are pricing
in a wave of bankruptcies that frankly hasn't actually happened yet. Precisely. Because if we look
at the actual loan book mechanics today, there are non accruals, which are loans that have completely
stopped paying interest and are structurally in default. Those sit at just 0.1% at fair value.
That's practically nonexistent. It really is. Additionally, their leverage ratio is only 0.93X.
Meaning they're carrying less debt than the equity they hold. Right. They are not dangerously overbarrowed.
So as an investor, the analytical task is deciding. Has the market correctly identified a looming AI
title wave? Or has it severely mispriced a fundamentally sound portfolio of loans?
And that is the risk with private credit. But let's look at the other way retail investors are
chasing double digit yields right now, covered call ETFs. These have exploded in popularity.
Totally. Funds like JEPQ or QQQI, they've absorbed billions in assets because they pay
10 to 12% a year and they distribute it monthly. Which people love. But our sources identify
a structural flaw in these funds. They call it the growth ceiling. Yeah. And to understand the
growth ceiling, you really have to understand the mechanics of a covered call option. Walk us to it.
So these funds buy a basket of technology stocks. To generate that massive 12% cash yield,
they sell call options against those stocks. Right. Selling a call option basically means you sign a
contract agreeing to sell your shares at a predetermined price, the strike price, no matter how high
the stock goes. Okay. You get paid a hefty cash premium today for finding that contract. And
that premium becomes the funds dividend. It's essentially like installing a speed governor on a
high-performance sports car. Exactly. You get a very safe predictable ride. But the second you take
it to the track and the overall tech market explodes on a massive bull run. You are just left in the dust.
Because you gave away the upside. Right. You agreed to sell your shares at say $110. Even if the
market price rocketed to $150. Over a 20-year timeline, capping your upside market growth like that
is a devastating drag on compounding. It really is. You are sacrificing hundreds of thousands of
dollars in total wealth just for the comfort of a monthly payout. The opportunity cost is massive.
Which is exactly why financial engineers are currently obsessed with building funds that can
deliver that 12% yield without imposing that strict growth ceiling. And the research actually
surfaced a few attempts at this. Like BALQ, the iShares NASDAQ premium income active ETF.
Right. They charge a 0.35% expense ratio, which is incredibly aggressive pricing for this space.
But it's their mechanical two engine strategy that I found fascinating.
It's a really clever structural workaround. Engine 1 is just the traditional approach.
They take 80% of the portfolio's capital, hold big tech stocks, and sell covered calls on them
to generate the core 11-12% yield. Okay, so 80% of the money still has a speed
governor on it. Yes, but engine 2 utilizes the remaining 20% of the capital. They use that slice to
purchase NASDAQ 100 futures contracts. Oh, interesting. Right, because futures provide leveraged
uncapped exposure to the underlying index. So in the tech market goes on a massive run.
The futures contracts mathematically capture the explosive upside that engine 1 contracted away.
That's smart. Now, Shellen Capital is taking a similarly tactical approach with two of their ETFs,
SPQ, and SEPI. Yeah, they're doing some interesting things. SPQ combines tech stocks,
blends and treasuries for crash protection, and then uses a mechanism called NASDAQ call spreads
to reduce the growth ceiling. And the data shows it's actually working.
What are the numbers? Over the past year, SPQ actually beat the S&P 500 total return 23.6%
versus 20.38%, while simultaneously paying an 11.33% yield. That's impressive. And the call
spread is the key mechanic there. How is a spread different? Well, if you just sell a standard covered
call, your upside is capped entirely. A call spread means you sell a call option close to the current
price to generate income, but you use a portion of that income to immediately buy another call option
further out. Oh, okay. So you cap your growth within a very specific price band, but if the stock
absolutely rockets past your higher strike price, you participate in that extreme upside again.
It's like a highly engineered safety valve. And what about SEPI? SEPI takes a slightly different route.
They utilize individual stock-covered calls rather than the broader index, and that yields around
8.4%. But for both of these, we really have to look at the tax mechanics. Right. Taxes always
complicate things. They do. Because a significant portion of the income distributed by these options
base funds is classified for tax purposes as return of capital or ROC. Wait, how does return of
capital actually work when you file your taxes? Is it just untaxed income? Not exactly. I mean, return
of capital is not taxed as ordinary income in the year you receive it, which feels great. Yes,
that sounds perfect. But mechanically, every dollar of ROC you receive lowers your original cost basis
in the fund. Oh, I see. So if you bought a share for $50 and received $2 in ROC, the IRS now considers
your purchase price to be $48. So you don't pay taxes today. But when you eventually sell the fund
years later, your capital gains will be larger. It is a powerful tax deferral mechanism that allows
the money to compound more efficiently in a taxable account. But the tax bill absolutely eventually comes
due. And crucially, with any of these complex option strategies, you are entirely reliant on the execution
skills of the human managers running the fund. Completely. You're betting on the jockey, not just the
horse. Right. Okay. So we've looked at all these modern highly engineered solutions, but I saved
the most baffling piece of research for last. The impossible dream. Yes. We found a fund that is
widely referred to as the impossible dream. It targets an 8% yield. It claims to crush the broader
market over the long term. And it isn't some new experimental ETF. No, it's been around forever.
It's the Adams diversified equity fund ticker ADX, a closed-end fund that has been operating
continuously since 1929. And the historical performance data on ADX is genuinely staggering.
It's crazy. If you had invested $10,000 into ADX in 1993, the research shows it grew to $463,000.
That exact same 10 grand in the S&P 500, like SPY, only grew to $316,000. A massive difference.
It outperformed the market by nearly $150,000, all while throwing off massive cash distributions.
How does a century-old fund mathematically achieve that? The answer lies in how a closed-end
fund distributes capital. ADX does not generate its 8% yield solely from the dividends paid by the
companies it holds. Where does it come from then? It generates the vast majority of that yield
by actively selling its winning stock positions and passing those harvested capital gains directly
to you the shareholder. Hold on. If they are just selling the stocks I already own a piece of and
handing me my own money back, how are they actually building wealth? Because they have historically
been excellent stock pickers during bull markets. They capture enough underlying growth to offset
the capital. They are continually distributing. Okay, but this mechanic introduces a severe vulnerability
doesn't it? What happens when the broader market crashes and there are no stock gains left to harvest?
That is the exact catch. Because they still have a target yield to hit. Exactly. They are structurally
forced to sell assets in a down market to meet their distribution goals. Oh no. Yeah. They are
liquidating holdings at deeply depressed prices. This is why in the .com crash of 2001, the 2008
financial crisis and the 2022 rate shock ADX suffered worse drawdowns than the S&P 500. That makes
total sense. And furthermore, because the payout is tied directly to market performance, the income
is violently volatile. How volatile? Well, in 2021 when the stock market was soaring ADX's distribution
despite to an equivalent 35 percent yield. 35 percent. But just a few years later as the market
cooled, it crashed rapidly back down to 8 percent. Man, if you are a retiree who requires a perfectly
stable, predictable monthly income to pay for groceries, a payout structure that swings from 35
percent down to 8 percent is going to give you motion sickness. It's a brilliant wealth compounding
machine, but it requires a rising stock market to fund its dividend. Which really brings us full
circle. It does. Because whether you are evaluating SCHD as a supposed safety net or
screening utility stocks for a 3 percent yield or hunting for a 12 percent payout in an actively
managed options ETF, you cannot simply look at the headline yield. You have to interrogate the
underlying mechanics generating that cash flow. Total return is the only metric that matters.
Understanding exactly what is inside the wrapper and aligning the mathematical reality of the tool with
your specific investing timeline that is how you actually build and protect wealth over a lifetime.
You know, there's one final concept from the research worth reflecting on for anyone listening.
What's that? If a hyper growth AI Titan like Nvidia is suddenly transforming into one of the most
significant dividend payers on the planet and traditional supposedly safe dividend funds are
suffering crashes identical to regular volatile equities. Yeah. Are the rigid historical definitions
of growth versus income completely obsolete? And if those definitions are dead, is your portfolio
built to survive the past or the future? Wow. That is a question every investor has to answer by looking
at their own holdings. Well, thank you for joining us on this deep dive into the underlying mechanics
of income investing. Keep questioning the headlines, keep demanding to see how the engine actually
works and we will see you next time.