Ep 27: Income ETF Stress Test, Defensive Dividends & High-Yield Hidden Gems

you know when you watch a master illusionist at work the entire performance relies on this one
very specific psychological trick right like misdirection oh absolutely the whole look over
here strategy exactly the magician flourishes this incredibly bright flashy red silk scarf in
their right hand and you intuitively just lock your eyes onto it because your brain is wired to track
the movement you know the color the spectacle right and because you are so hyper focused on that red
silk you are completely oblivious to the fact that their left hand is quietly like methodically
picking your pocket yeah the human brain has a really hard time processing the mundane reality
of the left hand when the right hand is offering this massive immediate dopamine hit well yeah and
you are so focused on the visual instantaneous reward that you completely miss the underlying mechanics
of what is actually happening to your wallet which is terrifying when you apply it to investing
totally and when you step into the world of dividend investing especially in the highly volatile
market environment we are navigating right now that double digit like we're talking 10 11 maybe
even 12% dividend yield yeah that is the flashy red silk scarf it really is it is the ultimate
financial misdirection I mean it is incredibly comforting to see a massive cash deposit hit your
brokerage account on the 15th of every month how it feels amazing it feels like a tangible victory
but if you aren't watching the other hand if you aren't looking at the underlying capital base
that's generating that cash you might be slowly losing your shirt without even realizing it until it's
far too late right so if you are joining us today we are going through a massive stack of research
from the informed investing universe and our mission for this deep dive is to completely
rewire how you look at income generation it's a full tear down and rebuild really exactly we are
going to separate the sustainable ironclad income strategies from the the yield traps that are
quietly almost invisibly liquidating your capital because there are a lot of them out there right now
so many we're going to explore a mathematical framework that instantly exposes flawed income ETFs
we will look at why utterly boring consumer staples are suddenly crushing the broader tech heavy
market which is wild to see it is and we are going to uncover high yield purely physical assets
hiding in plain sight that are you know completely immune to the current hysteria surrounding
artificial intelligence because the stakes for getting this right have rarely been higher I mean we
are operating in a market right now that is priced for absolute perfection right price to the absolute
limit yeah yet there are hidden systemic risks lurking just under the surface things like the massive
highly opaque private credit market which we definitely have to dive into today we will in an
environment like this chasing a flashy 10% yield without lifting the hood to see exactly how that
sausage is manufactured is just financially dangerous today is about aggressively shifting your focus
toward total return absolute structural safety and cash flow that is genuinely sustainable over a
multi decade timeline so let's start by lifting the hood on that yield trap the informed investing
research includes this massive comprehensive stress test of 35 different high yield income
exchange traded funds or ETFs the results were pretty shocking honestly yeah the data reveals a reality
it is going to make a lot of retail investors very uncomfortable like many of the most popular
highly traded income funds on the market are experiencing massive capital erosion you are literally
getting poorer while feeling rich right so break this down for us it's a brutal reality check for
anyone who just you know sorts a list of ETFs by the highest yield and clicks by yeah that's the
worst way to screen for stocks so the framework we use to understand whether an ETF is actually
generating income or just cannibalizing itself is called the distribution coverage ratio or the DCR
the DCR got it right and the beauty of the DCR is that it is totally unemotional it doesn't care
about the fund managers narrative or the slick marketing brochure it just looks at the cold hard
numbers exactly it just measures exactly how much actual organic income a fund is generating
internally compared to how much cash is paying out to you the investor so break the math down for
us if I run an ETF through this DCR test like what are the numbers actually telling me it's a really
simple ratio if a fund has a DCR above 1.0 it means it is generating more internal income than it
is distributing out as a dividend okay so give me an example sure let's say a fund generates a
dollar and 20 cents an income per share internally but only pays out one dollar to you that gives it a
DCR of 1.2 because it's covering 120 percent of its payout exactly it is sustainable it is actually
keeping a little bit of excess capital to grow but if that DCR falls below 1.0 it means the fund is
over distributing oh yeah it does not have the organic cash flow to cover the massive yield it
promised you so how does it pay you where does the money come from it has to eat into its own net
asset value it's NAV it is literally selling off its underlying assets or just returning your own
principle back to you and classifying it as a quote unquote dividend wow it's the equivalent of a
farmer eating their own seed corn like you sit down at the table a day you feel completely full you
feel rich holding all that grain but you're destroying tomorrow's crop exactly when planting season
comes next year you have fewer seeds to plant so your crop next year is mathematically guaranteed
to be smaller and the year after that even smaller yeah you are consuming your future capacity to generate
wealth just to feel fed today that is the exact mechanism of capital erosion and when you apply this
DCR stress test to the landscape of high yield ETFs it acts like a black light in a hotel room oh that's
a gross analogy but totally accurate right it illuminates everything you weren't supposed to see
the research names names and the disparity is wild let's hear the winners first on the winning
side you have funds like the BNY Millen high yield beta ETF ticker BYW sitting with a DCR of 1.62
that's massive coverage huge they are generating way more than they pay out you have the
fidelity high dividend ETF FTHI sitting at 1.30 or higher the first trust S&T 500 diversified free
cash flow ETF PBP is at 1.19 if TQI is at 1.07 so these are the funds planting their seed corn they
are actually building value exactly but then you look at the losers and it's an absolute blood bath
tell me about the losers but the global X-Tow Jones industrial average covered call ETF has a DCR
of 0.76 and a familiar wildly popular retail names like QILD X-Y-L-D T-L-TW well you see those push
all over social all the time and they are consistently bleeding out their net asset value
they're all sitting well below 1.0 we really have to ask a critical question here why do the global
X-FUNs and others like them struggle so profoundly with this capital erosion because they aren't run by
stupid people right no absolutely not they're run by incredibly sophisticated financial engineers
the problem isn't incompetence the problem is the structural reality of their core strategy okay so
what is the strategy these specific funds generally write what are called at the money covered
calls on 100 percent of their portfolio okay let's pause and translate the mechanics of that for
second because understanding the options market is key to understanding why these funds are eating
their seed corn yeah it's a bit technical but so important right so writing a covered call means
the fund physically owns the underlying stocks say a basket of the Nasdaq 100 or the S&P 500 they
own the actual shares yes then they sell an options contract to another investor in the open market
that contract gives the buyer the right but not the obligation to buy those exact stocks away
from the fund at a specific predetermined price on a specific date right and in exchange for giving
that buyer that right the fund collects a cash premium upfront exactly and that upfront cash premium
is the raw fuel they use to pay out that massive 10% or 12% dividend yield to you it sounds like
a brilliant synthetic way to manufacture high income from stocks that otherwise don't pay much i mean
tech stocks don't usually pay 10% yields they definitely do not but here is the fatal structural
flaw in doing that on 100% of the portfolio at the current market price which is what at the money
actually means right walk me through the math there if the stock is trading at $100 today
you write a contract agreeing to sell it at $100 and 30 days right so if the market suddenly
goes on a massive bull run and the stock rockets upward to $120 you don't get to keep that $20
of profit you get none of it your stocks get called away at the agreed upon $100 price you have
effectively mathematically capped all of your upside appreciation you collected your little cash
premium but you completely missed the massive market rally which is painful but what happens if the
market crashes what happens if that $100 stock drops to $70 while the buyer of the contract obviously
isn't gonna force you to sell them the stock for $100 when they can just buy it on the open market
for $70 right they'll be losing 30 bucks exactly so the contract expires worthless
the fund keeps the premium but the fund is also still holding the actual stock so the funds net
asset value just plummeted by $30 yeah that is the asymmetry that destroys wealth over time
you are fully exposed to 100% of the market drops because you hold the underlying assets
but you have contractually signed away all of the market upside you capture the downside but not the
recovery exactly if a stock drops from 100 to 50 you take the full hit when it eventually
recovers from 50 back to 100 your upside is capped every single step of the way because you keep
writing new at the money calls at 50 then 55 then 60 so your portfolio is slowly methodically
just ground down into dust it is and the data shows the real world consequence of this asymmetry
it's staggering to just maintain your original $10,000 investment in some of these flawed fully
covered call funds you would have to manually take the dividers they pay you and reinvest 25%
or more of them right back into the fund wait really 25% yes think about the psychological trap there
you bought the fund because it advertised a 10% yield you wanted $1,000 a year to spend on your
lifestyle you know pay for a vacation or groceries right that's what people buy them but because the
underlying asset value is shrinking so fast if you actually spend that full $1,000 next year
your principal will only be $9,000 so to stop your principal from evaporating you have to hand
a quarter of your dividend right back to the manager exactly so you aren't really earning a 10% yield
at all your true spendable economic yield is vastly lower wow this sounds incredibly bleak for anyone
looking to generate income from the options market it does but there's a silver lining right the
research points out that you don't actually have to abandon covered call strategies entirely you
just have to fix the broken mechanics you have to find a manager who isn't capping 100% of
their upside and this is where the info cap equity income fund ETF ticker icap he steps in as a really
great antidote tell me about icap i sap is a brilliant case study in how to use options responsibly
they take a fundamentally different approach instead of writing at the money calls on every single
share they own they utilize a partial coverage strategy partial coverage meaning what they typically
only write covered calls on about 30% to 40% of their underlying portfolio okay so that means they're
leaving 60% to 70% of their stocks completely unencumbered those shares have no contracts attached
to them at all precisely and that makes all the difference in the world by leaving the vast majority
of the portfolio completely free to run when the market inevitably goes on a bowl rally the fund
actually participates in it because they didn't sign away the rights to those shares right the rising
tide of the broader market lifts ICPs underlying net asset value and here is the secondary benefit that
most people completely miss as the NAV grows the stocks are worth more okay follow the logic there when
the stocks are worth more the options contracts they do write on that 30% sliver generate larger
absolute cash premiums a call option on a $150 stock pays more raw cash than a call option on a $100
stock oh wow I never thought about that it creates a virtuous cycle instead of a death spiral exactly
and the proof is right there in the historical data because of this partial coverage strategy icap
hasn't just maintained its distribution it has done something almost unheard of in the high yield
covered call space what is that it has aggressively grown its payout since its inception in
December of 2021 iTap has grown its distribution by a staggering 65% wait 65% growth on a high yield fund
yeah it went from paying out just over 17 cents a share to nearly 29 cents a share they are currently
maintaining what is known as a 5.33% SEC 30 day yield okay let's quickly define that for you because
yield is a term that gets manipulated a lot in marketing materials oh massively manipulated when
you see SEC 30 day yield that is a highly standardized metric mandated by the securities and exchange
commission it forces the fund to show you an annualized yield based purely on the actual income earned
over the last 30 days minus the funds expenses right it prevents a fund from having one freakishly
good month paying a massive special dividend and then advertising a 20% trailing yield for the rest of
the year which happens all the time yeah the SEC 30 day yield is a much more honest standardized
snapshot of current reality it is the truth teller metric and maintaining a 5.33% SEC yield while
simultaneously growing the underlying NAV is basically the holy grail for these types of funds but as
with everything in finance it is not a free lunch right no definitely not we have to look at the trade
offs ICK is actively managed meaning human beings are making complex decisions right human beings are
deciding which options to write and when and that active management comes with a very steep price tag
the fund has an expense ratio of 2.96% whoa nearly 3% a year yeah that is incredibly high compared to
a passive index fund furthermore it's a relatively small fund with only about $90 million in total assets
under management so you are paying a massive premium for the management teams expertise but I guess
the core takeaway from the informed investing research isn't necessarily that you have to rush out and
buy ICP today no not at all the lesson is that a distribution coverage ratio above 1.0 is absolutely
possible in the complex options space but only if the strategy purposefully refuses to cap all of its
upside which naturally leads to a philosophical realization if generating high yield through complex
financial engineering options contracts and derivative overlays is this treacherous and requires
paying a manager nearly 3% a year just to avoid liquidating yourself right perhaps there is a
profoundly simpler way to achieve your goals when financial engineering gets too complicated and the
risk of error is this high sometimes the smartest move an investor can make is to step back clear the
board and look at the most basic fundamental human behaviors driving the global economy and that brings us
to an incredible realization hiding in plain sight if you want to avoid the yield trap you might need to
embrace the radical power of being completely unapologetically boring boring is beautiful and investing
it really is we are looking at market data right now that shows a glaring almost unbelievable divergence
let's look at the Vanguard consumer staples ETF ticker VDC okay let's look at VDC you're to date
this incredibly boring index is up 5.9 percent meanwhile the broader S&P 500 is down 4 percent
that is a massive nearly 10 percentage point gap in performance a 10 point spread between a sleepy
defensive staples index and the broader market is not a random fluctuation it is a flashing red
siren indicating a massive macro economic shift is underway beneath the surface look kind of shift
institutional money the billions of dollars controlled by pension funds endowments and sovereign
wealth funds that money is moving they're executing what we call a defensive rotation let's open a VDC
and look at the holdings driving this out performance because it is literally a shopping list of the
most mundane companies on earth VDC's top positions are companies like Walmart Costco proctor and gamble
and Coca-Cola it yields a very safe 2.13 percent and it costs almost nothing to earn with a microscopic
0.09 percent expense ratio super cheap right so why are the smartest financial minds on Wall Street suddenly
hiding out in isles 4 and 5 of the grocery store they're hiding in the grocery store because they are
terrified of what is happening outside of it I love that framing when the macro economic environment gets
murky when inflation remains stubbornly high when central banks are unpredictable with interest
rate policy and when geopolitical tensions are escalating globally institutions do not want to bet
their clients billions on speculative high multiple technology stocks right or highly cyclical consumer
discretionary companies that rely on people buying luxury cars or taking expensive vacations exactly
they crave absolute certainty and there is absolute mathematical certainty in the fact that no matter
how bad the economy gets no matter what the federal reserve does human beings are not going to stop
buying toothpaste toilet paper basic groceries and soda they just aren't but the research gets even
more granular while the broader consumer staples sector is holding up the market our sources highlight
two specific legendary blue chip companies within this defensive space that are currently trading
at incredibly rare anomalous discounts oh let's hear them let's look at the first one
home depot ticker HD this is the undisputed king of home improvement and it is currently down roughly
25 percent for its recent highs which is a huge drop for a company like that huge and because the stock
price is dropped its forward dividend yield has been pushed up to 2.85 percent paying out $9.32
per share annually okay and the second one the second one is PepsiCo ticker PEP the global snack
and beverage behemoth is down 22 percent pushing its yield up to a very juicy 3.87 percent paying
$5.92 per share to see world class wide-mode businesses like home depot and Pepsi trading down
20 to 25 percent is incredibly rare you have to understand that these are not fundamentally
broken companies right it's not like nobody is buying Doritos anymore exactly they aren't facing
existential threats to their business models they're simply experiencing temporary cyclical headwinds
maybe major home renovations have slowed down slightly because 30-year mortgage rates are
hovering near 7 percent making home equity loans way more expensive that makes 12 percent or maybe
snack volumes at Pepsi have dipped slightly because consumers are pushing back against years of
compounded inflation at the grocery store but the underlying infrastructure of these businesses
their supply chains their brand dominance their distribution networks remain absolute cash printing
machines wait hold on let me stop you right there because I can hear someone listening to this
screaming at their dashboard right now oh what are they yelling you're talking about a 3.87 percent
yield on Pepsi I can open my broker-jap right now tap a few buttons and buy a risk-free US treasury
bill that pays over 4 percent that's true you can and it is guaranteed by the United States government
so why on earth would I take equity risk the risk that Pepsi stock drops another 10 percent just to
secure starting payout that is lower than what I can get risk-free that is the defining question
of this current market cycle why buy stocks when cash pays 4 or 5 percent right why the answer to
that question lies in a very specific highly exclusive title that Pepsi co holds they are a dividend
king a dividend king yes Pepsi hasn't just paid a dividend they have actively increased their
dividend payout for 54 consecutive years wow 54 years think about what has happened in the last
54 years we have had wars massive inflationary spikes in the 1970s the dot-com bust the 2008 global
financial crisis and a global pandemic that shut down the entire world economy and through all of
that through every single one of those catastrophic events Pepsi co raised its dividend payout to share
holders the compounding mechanism is what people miss when you buy a US treasury bill that yield is
entirely static if you lock in 4.5 percent today you get 4.5 percent it will never grow now and
worse when that short-term bill matures in three or six months you have to reinvest your cash and
whatever the new prevailing interest rate is if the federal reserve has cut rates you might
only be able to reinvest at 3 percent you face massive reinvestment risk but when you buy shares
of a dividend king like Pepsi you are tapping into a dynamic growing cash flow stream your yield on
cost meaning the dividend you receive relative to your original purchase price grows every single year
right let's say you buy Pepsi today at that 3.87 percent yield if they continue their historical pattern
of raising their dividend by 6 or 7 percent a year a decade from now your annual payout might
represent a 7 or 8 percent yield on your original investment and crucially over that decade the actual
stock price is highly likely to have appreciated as the underlying business grew exactly treasury bills
give you flat ungrowing income that is slowly eroded by inflation dividend kings give you an
expanding income stream that historically outpaces inflation plus the capital appreciation of the stock
and the urgency behind this defensive rotation into stables isn't just about standard run-of-the-mill
recession fears or slightly slower consumer spending the informed investing research points to a
massive incredibly complex shadow looming over the broader financial system yeah this is the
scary part the institutions are running to safety because they are terrified of the 1.7 trillion
dollar private credit industry this is a critical systemic piece of the puzzle that most retail
investors are completely unaware of explain it to us what is private credit to understand the terror
surrounding private credit we have to look back at the aftermath of the 2008 financial crisis after the
banks melted down regulator stepped in with massive legislative frameworks like Dodd Frank forcing
traditional banks to massively de-risk their balance sheets right they couldn't just hand out
money to anyone anymore exactly thanks were essentially told they could no longer make high-risk
loans to heavily indebted middle-market companies but those middle-market companies still needed
to borrow money to operate to make acquisitions to build factories the demand for debt didn't
disappear the traditional suppliers of that debt just got benched exactly nature of horse of vacuum
and wall street of horse uncollected yield so massive private equity firms asset managers and shadow
banks stepped into the void yeah they started raising billions of dollars from institutional investors
to lend directly to these riskier companies over the last decade this private credit market has
exploded from a niche strategy into a 1.7 trillion dollar behemoth and what makes it a ticking time bomb
three massive vulnerabilities first the vast majority of these private credit loans are floating
rate meaning the interest rate changes right unlike a 30 year fixed mortgage where your payment is the
same forever floating rate loans adjust based on current interest rates when interest rates were
near zero these companies could easily afford the interest payments but as central banks aggressively
hiked rates to fight inflation the cost for these companies to service their debt absolutely skyrocketed
oh well a company that was paying 4% interest might suddenly be paying 9 or 10% on hundreds of
millions of dollars of debt which instantly destroys their profit margins and pushes them toward default
exactly second the underwriting standards the rigorous checks and balances to ensure the bar where
can actually repay the loan are largely hidden from public view because it's private right traditional
bank loans are heavily scrutinized by regulators private credit loans are private the terms are bespoke
and many analysts fear that during the boom years lenders got incredibly sloppy handing out massive
loans to companies with highly questionable cash flows just to put the money to work and the third
vulnerability the third vulnerability is the opaqueness of the valuations if a public corporate bond
starts looking risky the open market immediately prices it down you can see the bond dropping in value
every second of the trading day but private credit loans aren't publicly traded no they aren't
the private equity firms holding these loans largely get to mark their own homework they can look at a
struggling company that is barely making interest payments and say well this loan is still worth
a hundred cents on the dollar until the company completely defaults and files for bankruptcy right
which forces the lender to suddenly write down the loan to zero wiping out billions of dollars
and perceived value overnight that is the systemic shock that institutions are terrified of they don't
know who is holding the toxic debt because it is all happening in the shadows so if you are a multi billion
dollar pension fund manager and you are terrified that this one point seven trillion dollar shadow
banking system might start cracking where do you put your money you don't just hide in toothpaste and soda
no you need other options to you look for financial companies with absolutely zero exposure to private
credit you look for financial giants that make their massive profits purely on fees not on taking
lending risk the research highlights two phenomenal examples of the safe haven strategy the first is
ADP the global payroll processing giant the second is CME group which operates massive global derivatives
and futures exchanges okay let's break those down these are fundamentally financial companies
but they do not act like banks they do not lend money so they have zero risk of a borrower defaulting
let's look at ADP every two weeks millions of companies around the world have to pay their employees
it doesn't matter if the economy is booming or crashing payroll has to be processed right employees
want their money ADP handles the incredibly complex tax calculations the direct deposits the compliance
and for doing that they extract a fee it is a wildly sticky recurring revenue stream you don't
switch your company's payroll provider to save a few penny no the headache of switching is too massive
and CME group is even more fascinating from a structural standpoint they operate the exchanges
where the world trades futures contracts on commodities interest rates and stock indices like digital
toll booths exactly like that when a farmer wants to hedge the price of their wheat or a massive hedge
fund wants to bet on the direction of the S&P 500 they execute that trade on a CME exchange
and CME collects a microscopic fee on every single transaction but crucially CME isn't taking the
other side of the bet exactly they are purely the toll collector furthermore their clearinghouse
model ensures that they hold margin collateral from both the buyer and the seller if one party blows
up CME is protected by the collateral that's brilliant they take virtually zero credit risk they just
facilitate the global flow of risk collect their toll and pass massive amounts of free cash flow back
to their shareholders in the form of growing reliable dividends so avoiding the covered call yield traps
with a DCR metric is step one hiding in defensive staples like Pepsi and pure fee-based
financials like ADP and CME to avoid the systemic risk of private credit is step two but if your goal
isn't just to preserve capital but to build massive generational wealth over the next 10 or 20 years
how do you actually do it because the math proves that it isn't by starting with a static 8% yield
it definitely isn't the path to massive wealth is starting with a growing yield this is the pivot
from playing defense to playing offense the data we have from the informed investing research on
the Vanguard dividend appreciation ETF ticker VIG is staggering oh VIG I love this one we are looking
at a 10-year track record where VIG delivered a 223% total return let's just pause and let that
number sink in for you 223% total return over a decade and because it's a Vanguard index fund it
costs almost nothing in fees to hold right but here's the profound realization it achieved those
massive market-beating returns without ever chasing high flashy yield if you look at VIG's current
yield it's incredibly modest usually hovering under 2% that's very low initially the entire methodology
of VIG is ruthlessly elegantly simple it only includes companies that have a proven unbroken track
record of increasing their regular dividend payments for at least 10 consecutive years let's
lift the hood and look at the underlying mechanism of why that simple rule 10 years of dividend increases
generates a 223% return it isn't magic it is a phenomenal proxy for identifying elite business models
oh so think about what is required for a corporate board of directors to legally commit to sending
more hard cash out the door to shareholders every single year for a decade you cannot arbitrarily
raise your dividend for 10 years straight unless your underlying organic cash flows are consistently
growing right if you are a poorly managed company or if your business is highly cyclical like an oil
driller that makes billions when crude is at a hundred dollars a barrel but loses billions when it drops
to 40 you cannot sustain a growing dividend exactly when the cycle turns against you your cash
load rise up and you have to cut the dividend the 10 year growth rule acts as a natural
unemotional filter it strips out the poorly managed companies the boom and bust cyclical firms
and the highly indebted companies that are funneling all their cash to pay interest rather than
rewarding shareholders what you are left with is a concentrated portfolio of absolute global titans
Microsoft Johnson and Johnson visa proctor and gamble companies with massive competitive
modes pricing power and expanding margins the dividend growth is simply the exhaust fume of a
phenomenal underlying engine and the broader industry validates this approach completely morning
star the premier fund rating agency has awarded their highest possible gold ratings to both VIG and its
close cousin the Schwab US dividend equity ETF SCHD which utilizes a very similar quality first
dividend growth philosophy yeah SCHD is fantastic too they also highlight active management options for
investors who want a human hand on the wheel specifically pointed to TRO prices dividend growth ETF
ticker TVVG but to really grasp how this works let's look at a specific company mentioned in the
research that perfectly embodies this compounding philosophy RTX corporation RTX is a brilliant case
study in the optical illusion of yield it is a massive highly complex aerospace and defense contractor
they build everything from commercial jet engines to advanced missile defense systems huge company
now if you are a yield chasing investor and you run a stock screen looking for high income
you are going to completely ignore RTX why because it's starting forward yield is currently only
1.37 percent to someone addicted to that 10 percent covered call yield 1.37 percent is practically
invisible it doesn't even register as an income stock to them but the research points to a much deeper
the consistency grade RTX boasts an a plus consistency grade they have been paying an uninterrupted
dividend for 36 years and more importantly they have been actively growing that dividend payout
for 33 consecutive years this is where we have to fundamentally break down the mathematical concept
of total return it is the most common wealth destroying error in retail investing explain it to us
people think I want income so I must buy the asset with the highest yield available right now
they divorce the yield from the underlying asset let's run a hypothetical scenario to prove the
math imagine you have two choices choice a is a stagnant high yield asset maybe a flawed closed
and fund or a risky mortgage read that pays a flat 8 percent yield but the underlying asset value
never goes up in fact it might even decay slightly over time okay choice B is RTX starting at a
poultry 1.37 percent yield but the company is aggressively growing its earnings buying back its own
stock and raising that dividend by 8 to 10 percent every single year the math is brutal for choice A
if you buy the stagnant 8 percent yielder in 10 years you are still just getting an 8 percent yield
on your original capital which is nothing compared to inflation exactly inflation has been quietly
eating away at the purchasing power of that 8 percent for a decade your real return is significantly
lower but look at choice B with RTX that 1.37 percent yield is compounding annually at 10 percent
in 10 years your yield on cost might be 3 or 4 percent but wait that's still less than 8 percent
uh but crucially because RTX has spent a decade expanding its global defense business the actual
share price might have doubled or tripled uh toll return is the simple combination of capital
appreciation the stock price going up plus the dividends you collect along the way yes the compounding
growth of the underlying business combined with the escalating cash payout will utterly mathematically
destroy the stagnant high yielder over a 10 year horizon total return is the only metric that
truly dictates whether you are building generational wealth or just treading water which brings us to
the most difficult tension in dividend investing it is easy for us to sit here and extoll the virtues of
a 10 year compounding horizon but that assumes you have 10 years to wait right which not everyone does
exactly i want to interrupt this long term compounding theory and inject some harsh real world
reality into this conversation let's say you're listening to this deep dive right now and you aren't
45 years old trying to build wealth for retirement in 2045 okay you're 70 years old you're in
retirement right now you have a mortgage that is due on the first of the month you have grocery bills
that have inflated by 20 percent over the last three years you have rising medical expenses today
that's a very real scenario for millions of people you simply do not have the luxury of waiting
a decade for RTX is 1.37% yield to compound into something you can actually live on you genuinely need
an 8% yield right now to fund your life without selling off your principal yeah is there any structural
safe way to get immediate high yield without falling into the DCR covered call traps we diagnosed
earlier it is the single most common and most desperate question asked by retirees they need the
holy grail high yield that is actually backed by hard cash flow not financial engineer is it
exists it does and the informed investing research points to a very specific structural exception to
the general rule that high yield always equals high risk okay we are looking at a company called
western midstream partners ticker w e s and the headline numbers here are going to make any income
starved investors sit up and take immediate notice w e s is currently offering a massive 8.66
percent starting yield and arguably what is even more compelling than the sheer size of the yield
is the insider activity corporate insiders the executives and board members who see the actual daily
financial operations of the company are actively buying up shares with their own money the legendary
fund manager Peter Lynch had a brilliant framework for understanding insider behavior oh I love Peter
Lynch what did he say he noted that corporate insiders might sell their shares for a million different
perfectly benign reasons they might be selling to buy a vacation home or to pay a massive tax bill
or simply to diversify their portfolio so all their net worth isn't tied up in one company that makes
sense but insiders only ever use their own cash to buy shares on the open market for one singular reason
they have looked at the books they know the business intimately and they believe the price
is going to go up it is the ultimate vote of confidence but to understand how on earth an 8.66 percent
yield can actually be safe we have to deeply decode the specific business model of western midstream
they are structured as a master limited partnership or an MLP operating in the energy sector now when
the average investor hears energy sector they immediately envision wild terrifying swings in the price
of crude oil boom and bus cycles jeep geopolitical chaos dictating earnings and massive risk right you
think of oil rigs and wildcatters but and this is arguably the most critical distinction we will
make today western midstream does not drill for oil or gas they do not take exploration risk they don't
least land drill a whole two miles deep and pray they hit a gusher the mechanism of an MLP like
western midstream is entirely different think of them like a massive physical toll booth on the busiest
highway in the world I love the toll booth analogy keep going the operator sitting in that toll booth
does not care if a billionaire is driving through in a customized Ferrari or if a teenager is
driving through in a beat up 20 year old Honda Civic the toll operator has zero exposure to the
underlying value of the vehicles they simply collect a flat non-negotiable cash fee for every single
car that passes through the gate that is exactly how western midstream operates in the physical world
they own the pipelines the massive processing plants the storage terminals and the underlying
physical infrastructure that makes the energy sector function right they gather the raw unrefined
production directly from the well heads they process it to remove impurities and they transport it over
hundreds of miles to the refineries the research note that 90 to 95 percent of WES's entire revenue
stream is entirely fee-based which means they are almost completely insulated from the volatile
headline driven commodity prices of oil and natural gas if crude oil is trading at a hundred dollars
a barrel WES collects their fee if crude oil crashes to $50 a barrel WES collects the exact same
fee they get paid based on the sheer volume of material moving through their pipes not the fluctuating
market price of that material at its final destination as long as the wells are pumping the toll booth is
collecting cash and there is a fascinating almost hidden detail buried in the research regarding their
growth pipeline one of WES's most significant and stable growth drivers right now isn't actually
moving oil or gas why is it it is moving water moving water in the energy sector this is a phenomenal
highly unappreciated aspect of the modern energy infrastructure the hydraulic fracturing process
fracking requires injecting millions upon millions of gallons of highly pressurized water into the earth
to shatter the shale rock okay once that water comes back to the surface it is heavily contaminated
it cannot just be dumped in a river it must be carefully gathered transported via massive pipeline
networks treated and safely disposed of in specialized injection wells oh wow I never realized that
western midstream owns and operates the massive complex infrastructure required to handle that water
it is an enormous heavily regulated recurring purely fee based business that operates entirely
independent of the price of oil it is the ultimate infrastructural necessity but let's pause and do
a rigorous sustainability check we spent the very first part of this deep dive talking about the
DCR and how absolutely crucial it is to ensure that a massive dividend is actually covered by real
internal cash flow rather than the fund liquidating itself yeah we have to look at the math how does WES
look when we open the books and verify the math with master limited partnerships we don't look at
standard net income or earnings per share because the massive depreciation of their physical pipelines
artificially lowers their accounting profits right because of all that steel on the ground exactly
instead the north star metric for an MLP is called distributable cash flow or DCF DCF measures the
actual hard cash that the business generated from its operations minus the capital expenditures
required to maintain the pipelines leaving the exact pool of cash available to be paid out to
the unit holders so what are the numbers the data here is incredibly strong WES's distributable cash
flow per share sits at $4.85 their current annual dividend payout is only $3.64 so they have a
massive structurally sound buffer they were organically generating a dollar and 20 cents more per share
in pure unencumbered cash than they are paying out to investors that is the exact mathematical
definition of a safe exceptionally well covered high yield they aren't scraping the bottom of the
barrel they have excess cash left over after paying you 8.66% and that massive cash buffer allows
them to do something most high yielders can't they can actually grow they aren't just desperately
trying to sustain the 8.66% yield management is actively targeting three to five percent annual
distribution growth think about the power of that combination you are securing a massive starting
yield today to pay your bills and that yield is mathematically growing faster than the historical
rate of inflation protecting your future purchasing power furthermore if you look at their balance sheet
they are not aggressively over leverage to achieve this the research knows their leverage ratio
is a very healthy 3.18x let's quickly define that metric for you the leverage ratio measures a
company's total debt compared to its core earnings power specifically its EBITDA or earnings before
interest taxes depreciation and amortization a ratio of 3.18x means what exactly it means it would
take them roughly three years of current earnings to pay off all their debt entirely in the capital
intensive world of midstream pipeline infrastructure where massive debt is required to build the pipes
a leverage ratio under 3.5x is considered the gold standard of financial prudence it gives the
massive breeding room if interest rates spike or credit markets freeze exactly and on top of all
that financial engineering there is a massive incredibly powerful institutional safety net operating
directly underneath this company oh this is the part I love accidental petroleum ticker oh xy which
is one of the largest most powerful energy exploration companies in the world and heavily backed by
Warren Buffett's Berkshire Hathaway by the way on roughly 40% of Western midstream that alignment of
interest is the ultimate structural mode accidental isn't just a massive shareholder they are WES's
biggest most important customer any of those pipes accidental relies on WES's pipelines to get their
oil to market accidental is literally financially invested and ensuring that WES's pipelines stay
completely full operational and highly profitable if a vested interest in protecting that 8.66% yield
because they are collecting 40% of it what is fascinating about WES right now is the market
psychology surrounding the stock if you look at the chart the stock had an absolute incredible run
up 128% over the last five years as they repaired their balance sheet and grew their cash flow but over
the last 12 months the stock price has traded almost totally flat it is taking a breather but here is
where the fundamental laws of financial gravity come into play because the stock price has remained
flat while the cash flow and distributions have grown WES currently yield significantly more than its
direct peers in the midstream pipeline space in highly efficient markets glaring anomalies like that
usually trigger a mean reversion right one of two things has to happen either WES is forced to cut
its distribution which as we just proved with the $4.85 dcf is highly mathematically unlikely or the
share price has to fundamentally rise to bring the yield back down in line with the sector average
you are effectively getting paid nearly 9% to wait for the market to realize it is underprice the asset
it's a beautiful setup let's tie all of this together the absolute secret to western midstreams uniquely
safe 8.66% yield is its toll booth business model which is permanently irrevocably tied to hard
physical infrastructure in the real world you cannot virtualize a natural gas pipeline you cannot
put millions of gallons of contaminated fracking water into the cloud no it demands physical steel in
the ground which naturally got us thinking where else in the market can we find physical infrastructure
collecting toll booth like rents generating massive sustainable yields and operating completely immune
to the current frenzied hysteria surrounding artificial intelligence which brings us to the final
piece of the informed investing research and a profound look at the future of commercial real estate
we are looking at the massive virtually impenetrable AI proof mode of gaming reads we are talking about
real estate investment trusts specifically to major players GLPI which stands for gaming and leisure
properties and vci properties both of these reads are currently throwing off yields well north of 6%
and it's crucial to understand the scale of what we are discussing here we aren't talking about obscure
dying strip malls in the suburbs or massive empty office buildings in downtown tech hubs that have
been decimated by the work from home movement right vci owns the actual physical dirt and the
underlying structural buildings of some of the most iconic globally recognized properties on the
planet cesar's palace the mgm grand the vignetion on the Las Vegas strip the secret sauce to these
6% yields isn't the flashy casinos themselves it is the incredibly powerful legal structure of their
operating contracts these gaming reads utilize what is known in the industry as a triple net lease
if you genuinely want to understand bulletproof institutional great income generation
you must understand the profound mechanics of the triple net lease let's break down how it differs
from a normal landlord tenant relationship if i own a standard commercial building or even a
residential rental house i collect a rent check every month but out of that rent check i am legally
responsible for fixing the roof when it leaks i have to pay the skyrocketing local property taxes
and i have to cover the exorbitant property insurance premiums in a stammered lease the landlord
bears the massive risk of escalating operational costs but a triple net lease structurally
reverses that entire dynamic house under a triple net lease the tenant in this case the massive multi
billion dollar casino operator like mgm or cesar's assumes 100% of those costs the tenant pays all
the property taxes the tenant pays the property insurance and the tenant handles all routine maintenance
and massive capital expenditures wait really if the roof leaks over the casino for it cesar's palace
cesar's pays millions to fix it cesar's pays for it vci does not pay a dime wow the read literally
just a legal entity that checks the mailbox and caches a massive rent check it is the ultimate
pristine asset light business model cleverly disguised as heavy real estate it is pure unadulterated
cash flow and to properly value a read you don't look at standard accounting net income because
real estate accounting requires massive non cash depreciation charges that make the read look
artificially unprofitable on paper right similar to the pipeline depreciation we talked about earlier
exactly instead you look at a metric called affo or adjusted funds from operations affo adds back
that phantom depreciation and subtracts the actual cash spent on maintaining the properties
and because of the triple net lease structure vci's maintenance costs are virtually zero meaning
their affo perfectly mirrors their massive rent collection and these are not short term three
year commercial leases where the tenant can easily walk away these are incredibly complex 10 to 30
year contractual agreements and crucially those 10 to 30 year master leases have built in mandatory rent
escalations the rent goes up automatically every single year it is usually tied either to a fixed
percentage increase or directly linked to the consumer price index it is an automated legally binding
contractual hedge against inflation the casino operator has absolutely no choice but to pay the
escalating rent because if they default they lose access to the physical building and their entire
casino operations ceases to exist i want to circle back to the specific idea that the research highlighted
the concept of these properties being fundamentally AI proof right now we hear so much about software
eating the world about generative AI disrupting every white color industry about autonomous systems
replacing logistics why are these specific gaming reads considered entirely immune to technological
disruption it comes down to the undeniable power of the physical mode you simply cannot virtualize
the visceral tactile experience of walking into a massive multi billion dollar Las Vegas resort right
the world class dining the live entertainment the sheer physical awe inspiring scale of the architecture
the social dynamics of the casino floor it demands absolute real world physical participation you
can't put that experience into a VR headset no you can't furthermore the regulatory barrier to entry
is almost impossibly high if you want to start a disruptive software company you just need a laptop
an internet connection and AWS server space can write the code in your garage and deploy globally tomorrow
but you cannot easily obtain a highly restricted heavily regulated gaming license the states intentionally
limit the number of licenses to ensure the existing casinos remain profitable and can pay their
massive state tax burdens nor can you easily replicate the billions of dollars of existing physical
infrastructure the water rights the zoning approvals on the Las Vegas strip or in key regional
gaming hubs these gaming reads essentially operate legally protected physical regional monopolies AI
cannot write a line of code that disrupts a state mandated gaming license and the timing on exploring
these reads right now is fascinating from a valuation perspective both GLPI and VCI are currently
trading significantly below their historical sector median valuations on a price to Afo basis the market
is priced them as if they are struggling which the Afo data clearly shows they are not and there is a
massive highly predictable macro economic catalyst waiting in the wings that could violently
re-rate these stocks higher reads are historically highly sensitive to interest rates primarily because
they borrow heavily in the debt markets to acquire new massive properties if the Federal Reserve
continues to cut interest rates the macro economic math shifts entirely in favor of the reads their cost
of new capital plummets making future acquisitions highly accretive their profit margins naturally widen
and mathematically as the risk-free rate on those treasury bills we discussed earlier starts to drop
back down to 3% or 2% yield starved institutional investors will desperately flood back into the real
state sector hunting for yield driving the share prices of VCI and GLPI significantly higher it's
the classic textbook asymmetric setup you're getting paid a very safe inflation protected triple net
backed 6% plus yield while you patiently wait for the massive macro economic interest rate cycle
to turn permanently in your favor it's a great place to wait we have covered an incredible sweeping
amount of ground today let's loop back to the beginning of our mission we set out to give you a
complete actionable toolkit from the informed investing universe to completely rewire how you
look at dividend investing and we have done exactly that I think we really did you now have the
unemotional math of the distribution coverage ratio the DCR as your primary shield to spot bad fully
covered call ETFs that are slowly eating your seed corn you understand the profound compounding
math behind VIG and how consistent dividend growth will absolutely destroy stagnant yield chasing
over a 10-year horizon at 10-year horizon is key and most importantly you have the architectural
blueprint for finding genuinely safe massive high yield today look for businesses that act like physical
toll booths look for the fee-based MLPs operating critical water and energy infrastructure like western
midstream and look for the impenetrable AI-proof triple net lease REITs like VCI and GLPI the core unifying
lesson across all of this research by structurally sound cash flowing infrastructure not liquidating
assets dressed up in flashy red silk if we pull back the lens and connect all of these seemingly
disparate themes into the biggest macroeconomic picture possible I want to leave you with a final
highly provocative thought to mull over as you analyze your own portfolio this week all right here is
with it we spent significant time today looking at the terrifying vulnerabilities within the 1.7 trillion
dollar opaque highly stressed private credit market we also know that digital software and AI
related valuations have reached atmospheric almost historical heights based on assumed future
perfection right the market is incredibly top heavy with massive expectations baked into the tech
sector while a massive shadow banking system teeters underneath so as the mathematical stress
inevitably builds in the floating rate shadow banking system and as the overcrowded tech trade
eventually stalls or faces a regulatory reckoning what happens to the global flow of institutional
capital trillions of dollars have to go somewhere is it possible that we are currently standing on
the precipice of a massive historic completely unforeseen panic buying spree by institutions into
the exact boring totally physical pure fee based assets we discussed today wow think about the
implications of that you are suggesting that the multi billion dollar institutional money might
suddenly rotate violently out of the ephemeral cloud out of the opaque shadow loans and desperately
pour into the tangible reality of physical casinos critical water pipelines and consumer stables
exactly and if that generational rotation happens the sheer overwhelming volume of institutional capital
will drive the share prices of these limited physical assets so incredibly high that today's
6% and 8% entry yields will completely vanish becoming a nostalgic relic of the past that's a wild
thought could the ultimate safe boring defensive income plays of today actually be tomorrow's highest
appreciating most aggressive growth stocks simply because in a world obsessed with the virtual they
are tangibly irreplaceably real that is a fascinating paradigm shifting concept to explore on your own
it completely flips the script on what a growth stock actually is in the modern economy thank you
for joining us on this deep dive take a hard look at your own portfolio this week run your income
funds to the distribution coverage ratio test look under the hood make absolutely sure you aren't
staring at the flashy red scarf while your pockets are slowly being picked keep hunting for those
toll booths protect your seed corn and we will see you next time