Ep. 49: Dividend Growth vs High-Yield, Insider Buying & Morningstar Changes Mind

Imagine buying a fund that promises you this massive like 30% yield.
Oh, yeah, the dream, right?
Right.
It sounds like the ultimate financial cheat code.
But then within a few years, your actual initial investment has just plummeted.
You've lost like 70% of your money all while paying taxes on the privilege.
Yeah, it's a it's a brutal reality right now.
It really is.
And you know, welcome to the yield trap of 2026, which is exactly why we are
tearing into this topic today for this deep dive.
If we really need to, because we're looking at a landscape where the traditional
math of income investing has just been completely distorted.
Exactly.
And we have a massive stack of data to get through today.
I mean, for Morningstar's latest strategic shifts to some really deep cut
value line webinars inside or buying crackers.
And oh, this is the best part of brutal stress tests of 65 different high yield funds.
Yeah, that stress test is eye opening.
It's insane.
So the mission here is to decipher the modern landscape of dividend investing.
Because if you are out there right now, you know, just desperately searching for cashflow,
the options are paralyzing.
Oh, absolutely.
Like do you settle for the traditional plotting 3% dividend growers?
Or do you take a swing at this wild new wave of, I don't know, 15 to 30% ultra high yield ETFs?
Well, to answer that, I mean, we really have to look past the flashy yield
percentages plastered on the marketing brochures, right?
We need to dissect the actual mechanics.
And honestly, perhaps more importantly, the psychology of risk adjusted income, the
psychology is huge here, right?
Because right now the market is just flooded with products that look like income
engines, but are actually just portfolio traps.
Yeah, portfolio traps.
But before we go hunting for the highest yields, I think we need to address like the fundamental
premise here, does focusing on dividends even make mathematical sense anymore?
That is the big question.
Right.
I was looking at the recent research for Morningstar and their senior analyst, Christine
Benz recently confessed to completely changing her mind on dividends.
She actually called herself a flip flopper.
Yeah, her pivot is incredibly revealing because, you know, it highlights this real
tension between academic math and human behavior.
Yeah.
So, well, for most of her career, she advocated strictly for a total return approach.
And if you look at the historical data, her initial stance makes perfect sense.
I mean, back in the 1970s, dividends were the primary driver of wealth in the stock market.
They made up roughly 73% of total returns.
Wow.
73%.
So, which means back then if you weren't collecting dividends, you were barely even
participating in the market's growth, right?
Exactly.
But look at the last four decades, that dynamic has completely inverted.
Today, dividends only contribute about 12 to 16% of the total market return.
Wait, only 12 to 16.
Yeah.
So, if you isolate your portfolio to just dividend paying stocks today, you are
mathematically severely restricting your opportunity set.
Look at the data comparing a prominent dividend index like VYM to the broader market.
Over a recent 15 year period, VYM returned 11.98% annualized, which isn't bad.
But the total stock market returned 13.40%.
Okay. So, I mean, my initial hypothesis would be that total return is just mathematically
superior, but you get a higher annualized return plus you avoid the tax drag.
Right.
The tax drag is a huge factor because with total return, you control the tax event.
You only pay capital gains when you actively choose to sell a share.
But with dividend investing, the company forces a distribution onto you every single
quarter and you owe taxes on that cash, whether you needed it to pay bills or just reinvested it.
Exactly.
You're forced into a taxable event.
Right.
So, I like to think of it like an orchard analogy.
Total return is like chopping off branches of your apple tree to sell for firewood while
dividend investing is just picking the apples.
That's a great way to put it.
But if the math clearly favors the firewood approach, holding the broader market and just
selling off small pieces, why did a senior analyst at Morningstar suddenly flip flop and
endorse picking the apples?
Because she recognized that retirees do not live in a spreadsheet.
Fair enough.
Right.
She points directly to a piece of behavioral finance research called the Bird in Hand study
by Blanchett and Fink.
They found that investors, particularly those in the drawdown phase of their lives are
psychologically wired to prefer spending non-portfolio income.
Oh, so they prefer the feeling of caching a check over like cannibalizing their own
asset.
That is the core of it because, you know, logging into an account and actively selling off
shares of a company you believe in, especially when the market is down, it induces
incredible anxiety.
Oh, I can imagine hitting that cell button when you're down 20%.
Exactly.
But caching a dividend check, that's passive.
It feels like a genuine yield on the underlying asset and that brings us to the second, probably
more critical factor, volatility, right, volatility.
Go back to 2022.
The total stock market lost 19% of its value.
That dividend focused ETF we just mentioned, VYM, it lost less than 1%.
A 19% drop versus essentially flat.
That is a completely different emotional experience for an investor, completely different.
And behavioral finance tells us that investors destroy their long term wealth when they panic
sell during drawdowns, right, buying high and selling low, the classic mistake.
Exactly.
So if the psychological comfort of receiving a tangible dividend check combined with the
dramatically lower volatility of dividend stocks, prevents you from panic selling at the bottom
of a crash.
Yeah.
Then that slightly lower total return and the tax drag are entirely worth it.
It's basically the premium you pay for discipline.
Okay.
So if we accept that premise that the psychological comfort of dividends is a valid strategy,
the immediate challenge is figuring out how to actually find reliable companies, right?
Right.
How do you avoid the value traps?
Yeah.
How do you find the ones that won't suddenly slash their payout when the economy gets rocky?
Yeah.
And looking at the data we have, it seems to come down to systematic filtering.
Like the Schwab, US dividend equity ETS, SCHD is a prime example of this.
Oh, absolutely.
SCHD is a powerhouse.
It boasts a 13% compound annual growth rate since its inception in 2011.
And it operates on this really aggressive screening filter.
Yeah.
It operates on what we call a classic Buffett philosophy.
It isn't just sorting a spreadsheet by the highest yield and blindly buying everything
at the top.
Right.
It's for undervalued companies with a proven history of growing their payouts.
And it ruthlessly kicks out any company that fails to maintain those metrics after a year.
The data actually shows that this specific screening method has an incredible 90 to 91% success
rate in maintaining a healthy portfolio.
But for anyone who prefers picking individual stocks over ETFs, the value line strategy we
reviewed is fascinating.
Well, it really is.
It's so thorough.
Yeah.
So we outlined this hyperstrict five step screening process that whittled a massive
universe of stocks down to almost nothing.
It is a masterclass in risk mitigation.
They start with a broad universe and apply five specific gates, gate one, a safety rank
of two or higher.
And that immediately cuts the list to 424 stocks.
Let's pause on that.
Why start with safety instead of yield?
Because a high yield often indicates a distressed company.
It's a red flag.
A high safety rank ensures you are only looking at companies with minimal price volatility
and really strong balance sheets.
It makes sense.
Yeah.
And then gate two builds on that.
It requires a financial strength rating of A or better.
That drops the pool to 252.
Then gate three, they filter for a minimum dividend yield of 3% leaving 78 companies.
And then gate four is a price stability score of at least 90, which brought the list
down to 52.
But wait, I always thought dividend investors didn't really care about the day-to-day stock
price, so why demand price stability?
It ties back to the psychology we discussed earlier.
I mean, if your stocks price drops 40%, human nature dictates you will panic, regardless
of how safe that dividend seems.
Yeah.
That's true.
Furthermore, extreme price instability is often a leading indicator that institutional investors
see a fundamental problem with the underlying business.
So stability really matters.
And finally, gate five demands a five-year dividend growth rate of 8% or better.
Which took the final list from thousands of potential investments down to just six single
stocks?
Just six.
And the one they ultimately spotlighted was ABV, ticker ABBV.
Now I have to challenge this outcome a bit.
Sure good.
Because anyone remotely familiar with the pharmaceutical sector knows ABV has been bleeding lately.
Their blockbuster arthritis drug, Humira, lost its patent exclusivity.
Yes.
This patent cliff.
Right.
They are facing a tidal wave of cheaper, biosimilar competitors, and their profits have noticeably
declined over the last few years.
So how does a rigorous safety screener spit out a company with declining profits?
Well, this is where we have to separate backward-looking fears from forward-looking mechanics.
The market absolutely punished ABV for the Humira patent cliff.
But that cliff is largely in the rearview mirror now.
Really?
Yeah.
It counts for only about 7% of their total sales.
The underlying engine of the business has already shifted.
Their newer immunology drug, SkyRizzy, generated $17.5 billion last year, and has projected
to surge past $21 billion this year.
Oh wow.
Okay.
So this screener isn't just looking at the temporary dip.
It's looking at the foundation.
Precisely.
You pair that revenue replacement with ABV's low beta, meaning the stock is historically
much less volatile than the broader S&P 500, and its massive free cash flow.
Right.
Free cash flow is key.
Because free cash flow is the actual cash remaining after a company pays all its operating expenses
and capital expenditures.
It is the literal pool of money from which dividends are paid.
ABV's free cash flow provides a massive safety net, making it a textbook candidate for this
type of strategy.
Which brings up a really interesting pivot.
Because screeners are great for analyzing the math of what a company has already done.
If you want to know what's coming next, you look at what the people inside the building
are doing with their own wallets.
Insider buying.
Yes.
The insider buying trackers provided two incredible, completely contrasting case studies.
Nike and Taiwan semiconductor.
Nike is the perfect example of the tension inherent in insider buying.
We have seen massive, multi-million dollar purchases from Tim Cook who sits on the board,
and the incoming CEO, Elliot Hill.
But the fundamentals are in nightmare right now.
I mean, the stock has plummeted 66% over five years.
Net margins are shrinking.
Gross margins have fallen to 40.2% and they are projecting a devastating 20% drop in revenue
in greater China alone.
It's not a pretty picture.
So my instinct says these insiders must know a secret turnaround plan is about to be executed
that the broader market is just blind to.
That is the hope, right?
But you have to interpret insider buying with extreme caution.
There is an old market adage.
Insiders sell their company's stock for a million different reasons.
They need to buy a house, pay taxes, get divorced or diversify.
But they only buy for one reason.
They think the price will go up, however, thinking the price will go up and actually executing
a corporate turnaround are two entirely different things.
Executives often buy stock just to signal confidence to a panicking market.
With Nike, the payout racer, the percentage of their earnings eaten up by the dividend
is climbing into dangerous territory.
Underbying is a compelling data point, sure.
But against those deteriorating fundamentals, it is absolutely not a guarantee.
No, contrast that with tie-on semiconductor TSM.
The insider buying there is backed by fundamentals that look like they belong to a completely different
asset class.
It's a completely different, unbelievable net margins of 50.5%.
They are guiding for full year revenue growth above 30%.
And despite that explosive growth, it trades at a surprisingly compressed price to earnings
ratio of around 28.
The disconnect between TSM's flawless financial execution and its valuation is entirely due
to a geopolitical risk discount.
The data makes this very clear.
Taiwan's semiconductor manufactures the vast majority of its most advanced chips in Taiwan,
and China views Taiwan as its own territory.
And just to interject here for a new one listening, we are looking purely at the market mechanics
and how institutional investors price risk, we aren't taking any political stance whatsoever
on the geopolitical situation itself.
Oh, absolutely not.
The market operates impartially.
It sees an unquantifiable geopolitical risk, and it demands a discount on the stock price
to hold that risk.
TSM is attempting to mitigate this by spending billions to build new fabrication plants in
the US, Japan, and Europe.
Right.
Versifying their locations.
But those international plans come with significantly higher operating costs, which could
eventually compress those beautiful 50% margins.
You have this paradox, a company executing flawlessly bought heavily by its insiders, but
trading at a discount simply because of its geographic coordinates.
OK, so we've covered the reliable three to four percent yields you can find by screening
companies like Abby or holding ETFs like SCHD, but let's be honest about human nature for
a second.
It's inherently greedy.
It is.
When an investor is desperate for cashflow and sees an ETF promising a 20 or 30 percent yield,
it triggers something primal.
It feels like a loophole, like, why would I settle for a 3 percent when I can get 30?
So what actually happens when you reach for those astronomical yields?
You enter the danger zone.
The danger zone.
And the comprehensive stress test of 65 high yield ETFs that we looked at provides a really
sobering reality check.
If you take nothing else away from this discussion, understand this one metric, the distribution
coverage ratio.
OK, let's go on some time on this.
I was understanding this mechanism completely changes how you view high yield funds.
The distribution coverage ratio is a measure of exactly how much of the cash a fund pays
out to you was actually generated by the funds underlying investments.
A healthy, sustainable fund has a ratio of 1.0 or higher.
OK, so 1.0 means what?
That means for every dollar they hand you, their investments generated at least a dollar
in income or realized gains.
But if a fund yields 30 percent and has a coverage ratio of 0.5, it means half of that
massive dividend is an illusion.
The fund didn't earn that money.
The fund manager is simply taking a piece of your initial principle and handing it right
back to you.
It's the financial equivalent of eating your own tail.
Like it feels amazing when that massive deposit hits your checking account every month, but
your underlying asset is steadily evaporating.
And the horror story from the stress test that perfectly illustrates this trap is a fund
called IWNY.
IWNY is a masterclass in NAV erosion, NAV being the net asset value or simply the share
price of the ETF.
IWNY actively targeted a 30 percent annual distribution.
But if you look under the hood, it's coverage ratio since inception is a catastrophic 0.24.
Wait, 0.24, which means for every dollar they paid out to investors, the fund's actual investments
only generated 24 cents.
Exactly.
Another 76 cents was just the investor's own money being returned to them.
And the math of that is inescapable.
The underlying value of the fund collapsed.
An initial $10,000 investment withered to $4,000 and then continued dropping toward $3,000.
But here's the most devastating statistic from the stress test.
Those are so.
In 2025 alone, an investor would have to reinvest 89 percent of their distributions back into
the fund just to keep their initial principal balance from shrinking further.
I mean, wait, 89 percent, let's just let that sink in for a second.
You are receiving these massive distributions, triggering a massive taxable event and you
have to immediately turn around and pump almost all of that cash back into the ETF just to
tread water.
Exactly.
The stress test calculated that on a $10,000 investment, after that forced reinvestment,
you were left with a measly $558 in actual usable income.
That's a pressing.
The fund had a negative sharp ratio, meaning when you adjust for the massive risk you are
taking, the return is worse than terrible.
And it wasn't an isolated incident either.
The stress test showed another fund, QQQT, which targeted 20 percent income required a 51
percent reinvestment rate just to maintain the starting balance.
High yield does not equate to high return.
It's a huge misconception.
If a yield looks suspiciously high, the distribution coverage ratio will almost always reveal that
you are slowly liquidating your own portfolio and paying the IRS for the privilege.
Okay, so if 3 percent is too slow to generate meaningful cash flow, and 30 percent mathematically
destroys your wealth, where is the middle ground?
Is there one?
Yes.
The data suggests the actual sustainable sweet spot sits right between 10 and 15 percent.
And this is predominantly occupied by a new generation of options based ETFs.
Let's break down how these actually work, starting with the overlay funds like OVA and OBS.
The data showed their coverage ratios are consistently above 1.0, meaning 0 percent reinvestment
is required to maintain your principle.
Which is great.
But how are they generating 10 to 12 percent without eating their own tail?
They hold a portfolio of underlying stocks, and then they write credit spreads on the S&P 500.
Okay, that sounds like Wallsfree jargon.
What is a credit spread in plain English?
Think of it as selling specialized insurance to other investors in the market.
The fund manager says, I will guarantee to buy or sell the S&P 500 at a very specific slightly
out of bounds price.
Other investors pay a premium to buy that insurance.
As long as the market doesn't make a sudden, violent swing past those out of bounds prices,
the fund keeps the premium.
That premium is the cash they distribute to you as a dividend.
Ah, I see.
And that leads us to the NEOS ETFs, which seem to be dominating this 10 to 15 percent
space right now.
Specifically, SPYI, which tracks the S&P 500 and yields around 12.1 percent and QQQI, tracking
the NASDAQ 100 with a 14 percent yield.
Right.
There was a fascinating real-world portfolio example in the research using QQQI.
An investor built up roughly a $100,000 position, and it was spinning off a highly reliable $1,000
a month in passive income.
Yeah, it is a very aggressive accumulation strategy.
The investor was buying shares directly, but also selling put options, essentially getting
paid to promise to buy more shares if the price dropped to the $50 or $51 range.
There's more.
The ultimate goal was to scale the position to a quarter million dollars, generating a
permanent $2,000 to $3,000 a month in cash flow.
Now I have to play dollars advocate here.
If SPYI gives me a 12 percent yield, the coverage ratio is healthy.
My principle isn't eroding, and it utilizes section 12.56 contract weight actually explains
section 12.56 before I finished the thought because that tax treatment seems like a massive
advantage.
It is a massive structural advantage.
In plain English, these funds use specific index options that fall under section 12.56
of the IRS tax code.
This rule dictates that any profit made from these options is automatically taxed as 60 percent
long-term capital gains and 40 percent short-term.
Oh, wow.
It doesn't matter if the fund only held the option contract for three days, you still
get that highly favorable long-term tax rate on the majority of the distribution.
Okay.
So back to my question.
If I am getting a 12 percent cash yield, stable principle, and incredible tax efficiency,
why would I ever put my money in a standard boring index fund again?
Why shouldn't everyone just dump their life savings into SPYI?
Because there is no free lunch in the market.
You are making a distinct trade-off.
These options-based funds perform beautifully when the market is flat or drifting slightly
upward.
But the very act of selling those options, selling that insurance, inherently caps your upside.
If the S&P 500 subtly rockets up 25 percent in a year, a standard index fund will capture
all of that explosive growth.
The income fund will not.
You have traded your maximum growth potential in exchange for current, reliable cash flow.
You are raising the floor, but you are bringing the ceiling down right on top of your head.
Exactly.
To account for the fee drag, these synthetic strategies require active management.
The expense ratio for the NEOS fund sits around 0.68%, a fewer passive growth index fund
like QQQM charges just 0.15%.
Big difference over time.
Huge.
Over a 20- or 30-year accumulation phase, that half a percent difference in fees, combined
with the capped upside, will severely stunt your long-term compounding.
These ETFs are precision instruments designed specifically to generate income.
They are not designed to be the primary growth engine of a young person's portfolio.
Which really distills this entire deep dive into a single, cohesive thesis.
The end game of dividend investing isn't finding the largest number with a percent sign next
to it.
No.
The absolute goal is securing risk-adjusted income.
It is a balancing act.
If you want individual stocks, you use a ruthless screener like Value Line to find fortified
compounders like ABV.
If you want higher yield, you utilize tax-efficient options ETFs in that 10-15% sweet spot.
But in every scenario, sustainable income requires balancing the cash you extract today with
the preservation of your underlying capital for tomorrow.
Exactly.
And, if you are holding a portfolio right now, remember that while the cold math of total
return might look mathematically flawless on a spreadsheet, the psychological comfort
of the bird in hand is deeply powerful.
If prioritizing dividends prevents you from making a catastrophic emotional decision
during the next market crash, then it is a profoundly effective strategy.
That behavioral edge is undeniable.
But before we close this out, there is one final, unquantifiable risk to ponder for everyone
listening.
We'll lay it on us.
We spent a lot of time discussing how these sweet spot ETFs maintain their yields through
incredibly clever tax classifications.
We talked about SPYI leveraging section 1256 contracts for long-term capital gains.
Other funds like MLPI classify up to 91% of their massive payouts as return of capital.
Which is huge because it isn't taxed as immediate income but rather lowers your cost faces, effectively
deferring the tax bill until you finally sell the fund years down the road.
Exactly.
It is an incredible structural loophole that makes these funds immensely popular.
But here is the thought to leave on.
What happens if the IRS decides to rewrite the tax code on these synthetic option strategies?
If the government closes the section 1256 loophole or crack down on how return of capital is distributed,
would this entire modern ecosystem of 12-15% safe yields suddenly collapse under the weight
of ordinary income taxes?
Oh, man.
It is a systemic vulnerability that will never show up on a stock screen or a balance sheet.
But it is the silent variable underlying this entire industry.
That is a staggering variable to keep in mind.
I mean, the math of yield is clearly no longer a simple equation.
You aren't just looking at quarterly earnings anymore.
You are forced to navigate the geopolitical discount of microchips, the psychological motivations
behind insider buying, the devastating math of distribution coverage ratios, and now the
silent threat of IRS tax revisions.
But armed with the specific metrics and filters we unpack today, you definitely have a significantly
sharper map to avoid the traps and find the real engines of income.
Thank you for joining us on this deep dive.
Keep questioning the high yields, always verify the coverage ratio, and we will catch you next
time.