Ep. 71: Tactical Covered Calls, BDC Yield Traps & Dividend ETF Upgrades

What if I told you that the massive, you know, 14% dividend yield you might be
eyeing right now isn't actually a wealth builder, but like a perfectly laid trap
designed to just destroy your capital.
No, we see it all the time.
It's so common.
Right.
Because building a dividend portfolio is remarkably similar to building a house.
Everyone immediately gets obsessed with the flashy rooftop deck.
The massive double digit yields that look fantastic on a spreadsheet.
Yeah.
The curb repeal.
But if you build that beautiful deck on a cracked crumbling foundation right
before an economic earthquake hits, you were going to be in serious trouble.
That is the perfect framework for what we're seeing today.
I mean, the market is currently full of beautifully painted houses that are
fundamentally just sinking into the mud.
Right.
As income investors, we naturally like things to look sturdy.
But when you, uh, when you peel back the floorboards, the structural integrity
of some of these insanely popular high yield plays is completely compromised.
Well, welcome to today's deep dive.
We are thrilled to have you with us as we unpack the latest daily dividend investing news.
Our mission today is simple, but critical.
We're navigating a very tricky market environment where yield can either be your absolute best wealth
building tool or a devastating trap.
It really is a minefield out there right now.
It is.
So we are going to separate genuine, sustainable income from cyclical morages and fundamentally
broken businesses.
And we've got a fascinating stack of research to get you there.
I mean, we need to dissect why some of those high yield energy plays are tricking people.
Call out that specific 14% trap we just mentioned and look at where quoted insiders are aggressively
betting their own money at five year lows right now.
Yeah, that insider data is wild.
It is.
But to your point about building a house, before you chase high yield or complex auction strategies,
every single income investor needs a bedrock of wealth preservation.
Okay.
So let's start digging the footings.
If we need a concrete foundation, before even think about the rooftop deck, what does
a concrete foundation actually look like in today's stock market?
Well, it looks a lot like the utility sector.
I mean, they are the ultimate safe havens.
Makes sense.
Yeah.
If you think about human behavior during a severe economic downturn, the pattern is highly
predictable, right?
People will quickly cancel their streaming services.
They'll definitely delay buying a new car or skip a vacation.
Exactly.
They might even skip a mortgage payment.
They will pay their utility bills before almost anything else.
The lights absolutely have to stay on and the water has to flow.
That makes perfect sense.
And looking at the data, we have three heavy hitters that exemplify this.
First up is American electric power ticker AEP.
It's currently yielding 2.9%.
But what's compelling here isn't just the defensive safety, right?
They have a massive $72 billion five year capital plan.
Oh, it's huge.
What exactly are they building with $72 billion?
They're building the infrastructure for the next industrial revolution, honestly.
AEP has this 56 gigawatt contracted large load pipeline that they need to bring online
by 2030.
And that demand is being entirely driven by the explosion in data centers and industrial
manufacturing.
So AI basically exactly.
So you're getting a highly reliable 2.9% yield backed by 21 consecutive years of dividend
increases, but it's fundamentally tethered to the artificial intelligence and cloud computing
build out.
So you get the boring safety of a utility, but the underlying driver is cutting edge tech
demand.
Hmm.
That's awesome.
We also have consolidated Edison in the notes ticker ED, which delivers power to New York
City and yields 3.3%.
Yeah.
A literal dividend king.
Right.
52 consecutive years of uninterrupted increases.
That's crazy.
And finally, American water works ticker AWK yielding 2.9% and targeting 7 to 9% earnings growth.
So these are the defensive walls of the portfolio.
They are, but you know, a foundation doesn't just have to be a slow growth utility.
You can also build your foundation with companies that are relentless at organically compounding
their own cash flow, which brings us to a really interesting name in the research resmed ticker
RMD.
They manufacture specialized medical equipment primarily for sleep apnea.
And they have a massive 21.15% return on invested capital.
Yep.
Just to clarify that metric for a second for you listening.
We're not invested capital or ROIC essentially means that for every dollar resmed plugs
back into its own business, they're generating a 21.15% return.
Which is incredible.
That is huge.
But wait, they only yield 1.15%.
If we're focused on income in this deep dive, why are we prioritizing a tiny 1% yield?
Well, because immediate yield can be incredibly deceptive, you know, this raises a crucial question
about long-term sustainability versus immediate gratification.
Right.
I mean, a 6% yield is mathematically meaningless if the company slashes it to zero tomorrow because
they ran out of cash.
Resmed pays out less than a quarter of its net income to shareholders.
Okay.
So specifically, the notes say 22.39% payout ratio.
Precisely.
So they're taking the other 75% or so of their cash and aggressively reinvesting it at
that massive 21% return rate we just talked about.
Oh, I see.
So they're forcefully growing the underlying business, which eventually grows the dividend
organically over time.
Exactly.
It aligns perfectly with short dividends philosophy of, you know, guarding wealth by buying
high-quality businesses that control their own destiny.
They recently highlighted a group of a rated dividend champions companies with 25 plus years
of increases that act as pure wealth gardeners for this exact reason.
Yeah.
Let's quickly run through that list for everyone listening.
So they have the names.
We've got FACSET, ticker, FDS, Brown and Brown, ticker, BRO, Badger meter, BM-Law.
Watson Reuters, TRI, Steponco, SCL, ADP, H2O America, ticker, HTO, Bechton Dickinson, BDX,
the Marzetti company, MZTI and Abbott Laboratories, ABT.
That's a powerhouse list.
It really is.
But let's look at why a couple of these specific names actually guard your wealth.
Take FACSET or Badger meter.
What makes these businesses so resilient?
It really comes down to how sticky their revenue is.
I mean, FACSET provides financial data and software to massive institutional investment
firms.
When a bank integrates FACSET into its daily workflow, they almost never rip it out because
the switching costs are an absolute nightmare.
Oh, yeah.
Nobody wants to retrain their entire trading floor.
Exactly.
That creates highly predictable recurring revenue.
And then Badger meter makes water flow measurement devices for municipalities.
Cities do not stop measuring water consumption during a recession.
Both of these companies have pristine balance sheets, low payout ratios, and decades of dividend
growth because their underlying product is effectively immune to standard economic cycles.
That structural advantage is what lets you sleep at night.
So once your foundation is set with these individual wealth guarding stocks, a logical next step
is to broaden your exposure using ETFs.
Definitely.
But here is where it gets really interesting.
If you're just blindly buying the standard legacy dividend ETFs that have been around for
20 years, you might be leaving serious money on the table.
It's like using a five-year-old smartphone.
Yeah.
That's a great analogy.
Sure.
The old phones still make calls and send texts, but you're completely missing out on a much faster
processor, a better camera, and modernized features.
That is a fantastic way to frame it.
The entire ETF landscape has evolved dramatically.
Institutional managers have developed strategic upgrades that use much smarter forward-looking
financial screens rather than just looking in the rear-view mirror to see what a company did
a decade ago.
Let's unpack the mechanics behind some of these strategic swaps because the details really
matter here.
First, the research suggests whopping the wildly popular SCHD for RDVY.
Why make that move?
Well, SCHD is a classic, but RDVY, which is the first trust-rising dividend achievers
ETF, implements a much stricter financial health screen.
RDVY demands that every company in the fund has a cash-to-debt ratio over 50 percent and
a pay-out ratio under 65 percent.
Okay.
So by forcing a strict cash-to-debt screen, you're essentially filtering out the companies
that are borrowing money just to fund their dividend payments.
Exactly.
You are eliminating the financial engineering.
And because of those strict health screens, RDVY has actually outperformed SCHD by about
3 percent annually over the past 10 years.
Wow.
That is a meaningful difference.
Yeah, it adds up.
The next swap is moving from VYM to SYLD.
VYM is famous for just capturing high dividend yields.
The company can return value to you in other ways, like buying back their own stock or
paying down massive debts.
Does SYLD capture that broader picture?
It captures it perfectly, and that's why it's called the Cambria Shareholder yield ETF.
SYLD looks at total shareholder yield.
If a company pays a 2 percent dividend, but they're also buying back 4 percent of their
outstanding shares every year, your slice of the pie is growing significantly faster than
just the doden implies.
That's a much more holistic view of capital return.
I love that approach.
Yeah.
Swap number 3 is moving from VYG to DGRW.
VIG requires companies to have a strict 10-year history of growing their dividends.
That sounds great on paper, so what's the flaw?
The flaw is that it's entirely backward looking.
A 10-year history tells you who was successful, not who will be successful.
DGRW uses forward-looking quality screens, focusing on earnings growth, and return on assets.
Because of that forward-looking methodology, DGRW currently holds about 32 percent of its
weight in the technology sector, capturing the companies that are generating massive cash flows
today, and have the capacity to grow their dividends tomorrow.
That makes a lot of sense.
Swap 4 moves us from HDV to NoBL.
HDV uses a somewhat subjective, most-screening process to pick stocks.
But NoBL requires a strict, objective, 25-year streak of dividend increases, meaning you
only get true dividend aristocrats, which is much more reliable.
Swap 5 moves from DGRW to CGDV, which is a major shift because CGDV is actively managed
by Capital Group.
They only hold about 50 highly-concentrated picks.
Yeah, and we should highlight the final swap too, moving from the Legacy Fund DVY over
to SDOG.
Let's talk about the specific danger of Legacy Funds like DVY, because they're often weighted
by market cap or totally yield.
If one specific sector say the financial sector balloons in value, the ETF just blindly
follows it and gets dangerously overweight in that one area.
You suddenly have massive concentration risk without realizing it.
How does SDOG fix that?
Well, SDOG uses an incredibly simple but effective mechanical fix.
It takes the top five yielding stocks across all 10 major market sectors, and it equalways
them.
You have exactly 10% exposure to tech, 10% to healthcare, 10% to financials, and so on.
It completely eliminates the risk of a single sector bubble imploding and dragging your entire
income portfolio down with it.
So upgrading your ETFs improves your underlying equity quality and filters out a lot of hidden
risk.
But I want to pivot here for a second.
What if you're listening to this and thinking, well, a 3 or 4% yield from an upgraded
ETF is great, but I actually need more cash flow right now to cover my living expenses.
Yeah.
A lot of people are in that boat.
Right.
And you just don't want to take on insane speculative equity risk to get it.
What do you do?
If you need higher current income but want to protect your capital, you have to look into
engineered yield.
You manufacture the income using options.
And our research today includes a master class on this exact strategy from Kevin Simpson,
the CEO of Capital Wealth Planning.
He manages the Amplify CWP ETF suite.
So let's look under the hood of his flagship fund, D.V.
D.V.O. is a fascinating financial tool.
It reliably delivers about 4% to 6% in cash flow to you.
But the magic is in the breakdown.
Roughly 2% to 3% of that comes from standard high quality dividends.
And the other 2% to 3% comes from tactically writing covered calls.
Let's pause and explain that mechanism for a second because covered calls can sound super
intimidating.
Oh, definitely.
Selling a covered call basically means you own a stock and you sell a contract to someone
else, giving them the right to buy your stock at a slightly higher price within a certain
time frame.
They pay you cash a premium upfront for that right.
Exactly.
But here's my question.
If selling covered calls is essentially creating cash out of thin air, why not just write
covered calls on 100% of the portfolio and double the yield, give me 12% instead of 6?
Because the market never gives you a free lunch.
The trade off with a covered call is that you are mathematically capping your upside.
Right.
Stock you own suddenly explodes in value because of great earnings.
You have already legally agreed to sell it at that set price.
You get to keep the cash premium, but you miss out on all those massive capital gains.
OK, I see.
If you write covered calls on 100% of your portfolio, which is what funds like JEPI or QILD do,
you almost entirely miss out on long-term bull markets.
Your capital will stagnate.
Ah, that makes total sense.
You're trading future growth for immediate cash.
Exactly.
What Kevin Simpson does differently with Devo is that he only writes covered calls on 30% to
60% of the portfolio at any given time, and he writes them 5% to 7% out of the money, meaning
the stock has to go up decently before it even triggers.
OK, so it's a very targeted approach.
Very targeted.
He uses the options strategically for risk mitigation and to smooth out the cash flow, while leaving
the other half of the portfolio completely unencumbered to run and capture the market's
natural upside.
That is a brilliant balance of income and growth.
And he applies this same tactical approach to his other funds, right?
IDVO targets about 6% in international markets where volatility is a bit higher, so the option
premiums pay you more.
And QDVO targets roughly 10% by writing calls on highly volatile growth stocks like Nvidia.
Yeah, it's a very deliberate, transparent way to manufacture yield.
You know exactly how the sausage is made, but we have to contrast that engineered yield with
investors who try to find massive yields organically out in the wild.
Oh, boy.
This is where people get hurt, relying on commodity ETFs for steady, predictable income is
like trying to catch rainwater in a bucket during a hurricane.
That's a great way to put it.
Right.
You'll get plenty wet, but it's a terrible long-term plumbing system.
It really is.
And that is the perfect analogy for the eye share's global energy ETF, DICKER-I-XC.
Let's look at the raw numbers for I-XC, because on the surface, they look incredible.
The price is up 52% over the last year, and it's offering a trailing yield of about 3.7%.
Why is this a mirage for an income investor?
Because the payout swing violently, I-XC pays semi-annual distributions, and if you look at
the actual cash hitting your account, the June payout was drastically cut from the previous
year.
You really have to understand the mechanics of the underlying holdings here.
Okay.
Like what?
Well, companies like Conoco Phillips use a variable return framework.
Their dividend is mathematically tied to commodity prices.
When oil goes up, the dividend goes up.
When oil crashes, the dividend crashes.
Right.
And we have to put current oil prices into context.
West Texas Intermediate Crude Oil was recently sitting at like $112 a barrel, which is in
the 98th percentile of its trailing 12-month range.
Yeah.
That's incredibly high.
The average is usually around $71.
And we have to ask why it spiked to 112.
It was driven by intense geopolitical tensions in the Middle East and fears of supply disruptions
in the Strait of Hormuz.
That massive yield you're seeing on your screen is a geopolitical premium.
Wow.
It's a reaction to fear.
It is not driven by structural long-term everyday consumer demand for oil.
So what's the takeaway for you listening into this right now?
It means that when you buy energy stocks for income, you are actively participating in a
volatile cycle.
You are not protecting yourself from it.
Exactly.
I expect 20 to 30% swings in your dividend payments from year to year.
If you rely on that exact specific dollar amount to pay your mortgage every month, a sudden
drop in global oil prices will put you in a very dangerous position.
Energy yields are volatile, but at least the underlying companies are generally flush with
cash right now.
What's infinitely more dangerous to your portfolio is a sky high yield that exists solely because
the underlying business is collapsing underneath it.
Which brings us to the dividend traps.
And we have a severe warning in the research today about Goldman Sachs BDC, ticker GSBD.
For context, BDCs or business development companies essentially act like private banks.
They lend money to mid-sized private businesses that are just too small for traditional wall
street underwriting.
And right now, the dashboard for GSBD is flashing bright red.
Oh, yeah.
It boasts some mouth-watering 14.3% dividend yield and it trades at a massive discount.
On paper, yeah.
The stock price is around $8.91, but the net asset value is $12.17.
Just to clarify, net asset value or NAV means that if Goldman liquidated this entire loan
portfolio today and paid off their liabilities, a share should theoretically be worth $12.17.
Yet the open market is only willing to pay $8.91 for it.
Why the huge gap?
The market is discounting it because the underlying mechanics of their loan book are deteriorating
rapidly.
Net income plunged 50% year over year.
Wow.
Yeah, non-accruals jumped to 4.7%.
And non-accruals is just industry jargon for bad loans.
It means the mid-sized companies they lend money to have stopped paying their interest.
Furthermore, GSBD's leverage is sitting at 1.37 times, which is well above their target.
And here's the most terrifying statistic for an income investor.
Their net investment income for the quarter was $0.22 a share, but the quarterly dividend
they paid out to investors was $0.32.
They are not even earning enough money to cover the check they're writing to you.
It's a classic trap.
But it's vital to realize that dividend traps don't just happen in obscure high yield financial
sectors.
Let's look at a beloved global staple, Nestle, ticker NSRGY.
OK.
I am going to play devil's advocate here because if I'm listening to this, I'm screaming
in my dashboard.
Nestle is a massive global giant.
They make everything in the gross real, they have a decent 3 to 3.5% yield, and they're allegedly
pivoting to health and wellness.
Why does a global tighten like Nestle belong in a conversation about dividend traps?
Because sheer size does not equal fundamental quality, I mean, look at the mechanics of
their growth.
Nestle is currently operating as a C tier business.
Their revenue has been entirely flat at roughly $114 billion for 10 straight years, a decade
of flat revenue, 10 years, zero meaningful top line growth in a decade.
Meanwhile, their debt is growing.
They have a debt to EBIT ratio of 3.3.
Which basically means it would take them over 3 years of their core operational earnings
just to pay off their total debt, which is remarkably high for a consumer goods company
that relies on selling coffee and chocolate.
Exactly.
And to address your devil's advocate point, yes, they are massive, but their size is exactly
their problem.
They're a massive cargo ship that cannot pivot quickly, and they are actively losing market
share to cheaper private label grocery brands, particularly in massive growth markets like
China.
They have no real economic moat protecting their core products anymore.
Okay, let me throw one more curveball at you regarding GSBD, the 14% yielding BDC we talked
about.
The research notes the GSBD actually has a $75 million share buyback program, and the
COCEO recently bought shares aggressively.
Shouldn't we trust the insider confidence of the CEO putting his own money on the line?
It's attempting narrative, but the math just doesn't care about narratives.
Insider buying and GSBD cannot magically fix fundamentally poorly underwritten legacy
loans.
Right.
That makes sense.
As interest rates have stayed high, the mid-sites companies holding those loans are getting
squeezed.
If the loans go bad, the loans go bad, or regardless of whether the CEO is buying the stock,
the bad fundamentals completely outweigh the optics of insider confidence.
Okay, so if insider buying at a struggling, highly leveraged company like GSBD is a trap,
where should we actually pay attention to insiders scooping up their own shares?
You want to look for insider buying when the underlying business is undeniably high quality,
but the stock price has been crushed by temporary macro-level headwinds that have nothing
to do with the company's actual operational excellence.
It's like buying a popped-ear, heavy-winter coat during a sweltering July heatwaves.
Exactly.
Right.
It feels completely wrong to buy it right now, nobody else in the store wants it, but the
fundamental quality of the coat hasn't changed at all, and because it's out of season,
you're getting an absolute bargain.
That is exactly what is happening right now with mid-America apartment communities, ticker
MAA.
It's a real estate investment trust, or REIT focused on apartment buildings.
Let's address the July heatwave first, because the bad news is substantial here.
The stock collapsed from its peak of $230 in 2022, down to a five-year low.
They heavily focus on apartments in the Sunbelt region of the U.S., and right now, the Sun
belt is facing a 50-year record high in the delivery of new apartment buildings.
So much new supply.
There's simply too much supply flooding the market.
On top of that, the Federal Reserve's high interest rates are acting like gravity on
REIT valuations, because real estate inherently relies on debt to build and grow.
That is the macro-level headwind, but let's look at the quality of the coat itself.
As the stock price dropped, the dividend yield is now approaching 5%, specifically 4.65%.
Despite the macro-environment, MAA has organically grown its dividend by over 50% since 2020.
They maintain one of the absolute highest credit ratings in the entire REIT space, meaning
their balance sheet is fortified, and their tenants are incredibly strong, the average net
least to rent ratios around 20%, meaning their tenants can comfortably afford their rent
without straining.
Here's the major catalyst.
Multiple corporate insiders bought shares heavily in the last month, and that's the very
first time we've seen insider buying at MAA in over a year.
The structural difference between MAA and a trap like GSBD is profound.
For MAA, the bad news perced, the temporary apartment oversupply, the high interest rates
is fully known and already priced into the cheap stock.
But historical data shows their earnings hold up incredibly well during downturns.
The insiders know the balance sheet is pristine, they know the supply glut will eventually absorb,
and they're buying the dip.
That is how you use insider buying as a signal.
Wow, we've covered a massive amount of ground today.
Let's do a quick recap so you have all the key takeaways.
We started by emphasizing the absolute need to guard your wealth with steadfast utilities
like AEP and ED, and we explored how a rated champions like FACSET and ResMed use sticky
revenues to protect your capital.
We then walked through the mechanics of upgrading your ETF exposure, moving away from flawed
legacy funds to smarter forward looking screens like RDVY and SYLD that eliminate structural
risks.
We broke down how to tactically engineer your income with Kevin Simpson's covered call
approach in funds like DVO, which generates premium cash while protecting your upside,
unlike full coverage funds.
We warned you about the unpredictable cyclical nature of energy yields like IXC.
We dissected the actual math behind yield traps, showing exactly why GSBD's 14% yield is
mathematically unsustainable, and why a massive brand like Nestle can still be a fundamental
trap due to stagnant growth and high debt.
And finally, we found a genuine contrarian opportunity in Sunbelt Real Estate with MAA,
where insiders are buying a fundamentally pristine business facing temporary headwinds.
It all comes back to looking under the hood and understanding the why behind the yield.
But I do want to leave you with one final puzzle to mull over.
We started today by calling utility stocks the boring, concrete foundation of your portfolio.
But consider this, with the massive power-hungry artificial intelligence revolution and the
data center boom we talked about with EEP.
What happens if these boring utility stocks suddenly become the new high growth tech plays?
In the near future, the line between a slow and steady dividend pair and a high octane growth
stock might just disappear completely.
Keep a very close eye on your foundation.
You might just find that your concrete slab is actually sitting directly on top of a gold
mine.
Thank you so much for joining us on this deep dive.
Keep questioning the numbers, keep looking past the flashy yields, and we will catch you
next time.