Ep 31: Goldman Energy Picks, Realty Income Debate, 12% CEFs & Sanofi Bargain

you know, when someone buys like a really high performance sports car, everyone completely
obsesses over the engine. We look at the horsepower, the zero to 60 times, the top speed.
It's just human nature to fixate on the flashy part, right? The number that goes up the fastest.
Oh, for sure. But I mean, we're entirely wired to just stare at this pedometer. It represents
that pure, unadulterated growth. Right. But imagine taking that beautiful, high revving sports car
and driving it straight onto a dirt road that is just full of massive potholes, jagged rocks, heavy
debris. If you don't have the right suspension system built in, that world-class engine simply
does not matter. You know, it really doesn't. The vehicle is going to shake itself to pieces before
you ever reach your destination. Exactly. And that dynamic is precisely what we're exploring today
when it comes to, you know, your financial vehicle. So welcome to episode 31 of the informed
investing deep dive. We have a massive stack of sources on the table today. And our entire mission
is for you to understand how to build structure and truly protect your wealth using different
tiers of the dividend investing spectrum. Yeah. And it's a really fascinating mix of materials
we're going through for you today. Yeah. We've got some pretty sobering historical survival data
from the brutal 1973 bear market. That's courtesy of the multiplier. Along with deep dives into global
blue chips like Procter and Gamble and Sonofi. And we can't forget Goldman Sachs's latest strategic
energy plays plus some truly mind-bending math on closed-end funds that are yielding like over 12%.
Yeah. That 12% number always gets people's attention. It definitely does. And by the time we wrap up
this deep dive, you are going to understand why a 276% payout ratio isn't always the giant red flag
it appears to be. And why chasing those massive double-digit yields requires a highly specialized
strategy. But I think to understand the suspension, we first need to understand the engine.
Right. And for most investors, that engine is really the staggering compounding power of the
broader market. Exactly. The baseline we all know, or at least think we know, involves something
like Vanguard's S&P 500 ETF, VOO. Yeah. It's the quintessential wealth building baseline.
It just perfectly highlights the pure mathematical power of consistent long-term market
participation. So let's actually slow down and look at the math here because the numbers are staggering
when you let them breathe. Imagine you drop $10,000 into VOO today. Then you commit to adding just
$100 a week, which is $5,200 a year, a very realistic number for a dedicated saver.
Right, totally doable. If we model this out over 30 years, assuming the historical averages
of a 1.09% dividend yield growing at 7% annually, alongside an 8% share price appreciation,
and you keep your dividend reinvestment turned on, the results are wild.
The acceleration in the later years is what always catches people off guard.
Yeah, because after 10 years, you're sitting at roughly $90,000, which is great, but it feels like a
grind. Then after 20 years, you crossed $285,000. But at the end of that 30-year window,
you're sitting on an ending principle of $870,000. And here is the true magic of that compounding
engine, right? The out-of-pocket cost. Over those entire three decades, you only contributed a total
of $166,000 of your own money. Yeah, every single dollar beyond that is pure compounding growth.
Your money is working significantly harder than you are. I mean, that is the dream scenario,
a perfectly smooth highway for our sports car. But the model assumes a reality where you simply
don't need to touch that money while the market does its thing. We have to look at what happens
when the road conditions deteriorate violently, which brings us to the nightmare scenario.
According to the multiplier, if we really want to pressure test a financial vehicle,
we have to look back at the 1973 oil embargo. Yeah, 1973 was just brutal.
It was. That period represents a uniquely devastating scenario for retirees and investors,
primarily because it was a dual crisis. You didn't just have an economic slowdown. The stock market
dropped 48% and at the exact same time, inflation more than tripled. Crude oil surged from under $3
a barrel to nearly $12, almost overnight. If you were a retiree relying entirely on selling off
pieces of your portfolio to pay for daily living expenses, you were just in an impossible situation.
Because your purchasing power is evaporating due to inflation, meaning you need more cash just
to buy groceries, but you're being forced to sell your shares at rock bottom panic induced prices
to get that cash. Exactly. You are permanently destroying your principle. But the source data outlines
three distinct survival patterns for the retirees who actually made it through 1973 intact.
Yes, so those who survived structurally engineered their portfolios differently. First,
they held 18 to 24 months of living expenses in cash reserves. Things like T-bills,
which ironically yielded 78% back then that cash buffer bought them time. Second, they utilized
options income. Okay, wait, let's pause on that options piece because that sounds counterintuitive
to a lot of people. How do options generate meaningful income during a total market panic?
Well, it comes down to implied volatility. When market fear skyrockets,
the premiums that buyers are willing to pay for options contracts absolutely explode.
So savvy investors were selling covered calls or cash secured puts, effectively acting as
the insurance company. Oh, okay. Yeah, they were getting paid handsomely to take on the volatility
risk that everyone else was desperately fleeing from. That makes total sense you monetize the fear.
And the third survival tactic from 1973, which is really the core of our discussion today,
was owning dividend growth stocks. Precisely. The survivors on consumer staples, utilities,
and industrial companies that didn't just continue paying their dividends during the crash,
they actively increased them. Wow. Yeah, these investors completely decouple their retirement
cash flow from the daily valuations of their equities. It didn't matter if the share price was
down 40% because the cash hitting their checking account actually went up. I want to translate this to
a modern application because the math here is terrifying if you get it wrong. Let's say you have an
$800,000 portfolio today. You need $4,500 a month in expenses and social security covers $2,200 of that.
You have an income gap. Right. A pretty common scenario. If you rely on traditional portfolio
liquidation during a massive downturn, just selling shares to cover that gap, you might be forced to sell
off $53,000 worth of shares in a single year just to survive, which permanently locks in those
losses. Those shares are gone forever. You can never participate in the eventual market recovery.
But if you have structured income, meaning dividends and yields covering the vast majority of
that monthly gap, you might only need to liquidate $8,000 of principle. You are leaving the engine intact.
Over a 25 year retirement, that single difference in liquidation strategy can result in a
$150,000 to $250,000 difference in your lifetime portfolio value.
And this is what we call sequence of returns risk. The danger of experiencing a major market downturn
right when you begin withdrawing money. The core thesis from the 1973 data is that portfolio
structure matters far more than market timing. De-coupling your cash flow from share prices is your
ultimate defense. So if dividend growth stocks are the shock absorbers that allow you to
survive a bad sequence of returns, we need to look at the bedrock of those portfolios.
We have two global blue chips on our desk today that are effectively on sale, though both are facing
some very unique pressures. Let's start with Proctor and Gamble, ticker PG. I mean, this is the
definition of a dividend king. They boast 70 consecutive years of dividend increases. 70 years.
That's incredible. But right now, the stock has taken a bit of a hit. It's down about 15% from its
52-week high, trading around $144, which has pushed the yield up to a fairly attractive 2.93%.
Yeah, but that 15% drawdown isn't happening in a vacuum. PNG is facing highly tangible headwinds
right now. They have significant tariff pressures dragging on costs, particularly in their beauty
segment, and they're dealing with a strong US dollar, which is a massive headwind because 55% of
their revenues come from international markets. So when those foreign earnings are converted back
to a strong dollar, the margins just shrink. Exactly. But the metric that stands out most to me is their
organic sales volume. It was completely flat year over year. I mean, if they're growing revenue,
but the actual volume of goods sold is increasing, that tells me they are relying entirely on price
hikes. Yeah, that's spot on. They've effectively exhausted their pricing leverage with the everyday
consumer. People are pushing back on expensive razor blades and longer detergent.
That is a highly accurate read of the situation. The consumer is bulking at further price increases.
However, when we evaluate this as a bedrock dividend stock, we have to look past the top line
growth struggles and really examine the cash floor. Okay, so how does the foundation look?
The foundation remains completely solid. They generate $6.10 in free cash flow per share.
That easily covers their annual dividend of $4.23. So they have a 70% payout ratio,
which leaves plenty of buffer. Exactly. Their entire $10 billion dividend commitment for the year
is fully reported by pure operating cash flows. The analysis frames this 15% drop as a temporary
dislocation rather than a structural deterioration of the business model. The cash generation is robust.
Okay, moving from consumer staples to healthcare, we have a second blue chip across the pond,
French farming giant Sonofi, ticker S and Y. They're yielding a very attractive 5.4%, backed by a 31-year
streak of consecutive dividend increases. And the valuation looks incredibly cheap right now.
It does. Their PE ratio is sitting at 11.9, whereas their historical average is closer to 16.7.
The average fair value estimate is floating around $61, implying the stock is potentially
28% undervalued right now. Yeah, it certainly looks like a bargain on paper,
particularly when you factor in their absolute blockbuster drug, DuPixen,
which treats chronic inflammatory diseases. DuPixen sales are growing at 25% year over year
and currently bring in over 15 billion euros annually. Okay, but if I'm looking at this through
the lens of risk, that massive success is also a glaring vulnerability, isn't it? I mean,
DuPixen makes up a full one-third of Sonofi's 43.6 billion-year-old total revenue.
It's a huge chunk, yes. We all watch what happened to ABV back in 2019 when the market panicked
over the Humeera patent cliff. When a single drug drives that much of your cash flow,
losing exclusivity can decimate the dividend. I'm looking at a massive patent cliff risk waiting
to happen here. And the concentration risk is the exact reason the stock is trading at a discount.
The market is pricing in that exact fear, but context is critical here. The patent protection
for DuPixen lasts until the early 2030s. Oh, okay. They have some time. They have a significant runway
before generics can flood the market. More importantly, we have to look at how management is
aggressively deploying their current cash flow to bridge that gap. What's their strategy?
Are they just buying smaller biotech firms? It's actually a lot of internal development. Sonofi
is currently spending an incredible 20% of their net sales entirely on research and development.
They have 80 clinical stage projects in their pipeline with 28 of those sitting in phase three trials.
Wow, 28 in phase three, that's a lot. They are not resting on their laurels. They're actively
building the foundation for whatever replaces DuPixen long before the patents expire.
So Sonofi and PNG provide that consumer and health care stability. But I want to tie this back to
the 1973 oil embargo for a second. If inflation and global oil shocks are the crypto night that
destroys retirement portfolios, we need a way to hedge against modern geopolitical uncertainty.
And that leads us to the energy sector. Yes. Goldman Sachs just released a report highlighting five
bullish energy dividend picks amid ongoing geopolitical tensions, particularly regarding Iran.
And Goldman's top tier picks in this space are Conoco Phillips, Halliburton,
Kinetic Holdings, Oventiv and Schlumberger. Now, I naturally view the energy sector as a notoriously
wild volatile ride. Oh, absolutely. Historically, it has been. Right. It's an industry famous for
boom and bus cycles dictated by commodity prices. If I'm trying to build a stable financial suspension
system, I don't typically want to rely on a sector that collapses every time the price of oil dips.
I'm guessing these companies aren't just blindly drilling every patch of dirt they find anymore.
You've hit on the exact structural shift that has transformed the sector. Prior to 2020,
the entire industry basically operated under a drill at all costs mentality. They took on massive
debt to fund constant expansion, which made their dividends highly vulnerable to price shocks.
So that era is over completely. The modern energy sector is defined by rigorous capital
discipline. Okay, so instead of sinking all their cash into new wells, what are they doing with the
windfall from these higher oil prices? They are heavily focused on shareholder return programs.
Goldman's thesis is that these dividends are deeply supported by massive free cash flow generation.
Because there is a very real geopolitical premium on energy security right now,
these companies are intentionally distributing meaningful capital back to shareholders.
Through dividends. So steady dividends, yes, but also aggressive share buybacks.
By buying back shares, they reduce the total share count, making the remaining dividend burden
easier to carry even if oil prices soften. It acts as a direct structurally sound hedge against
inflation and geopolitical shocks. I see. Well, hedges and bedrock blue chips are fantastic for
long-term stability, but what if a listener's primary goal is simply covering their monthly
living expenses? If you're trying to pay the mortgage and the grocery bill, you don't want
quarterly payouts. You want pure, predictable, monthly cash flow. And that brings us to
realty income ticker symbol O. This is a behemoth in the space. They are a real estate investment
trust, commonly known as a REIT. Yeah, they're currently trading around $61 and offering an annualized
yield of 5.2%, which they pay out religiously every single month. They even recently secured a massive
$1 billion joint venture with Apollo managed funds showing they still have huge growth ambitions.
But there is a catch when you look at their numbers online, right?
Right. If an everyday investor runs realty income through a basic stock screener,
the metrics look absolutely terrifying. The screener shows a PE ratio of almost 53
and a staggering 276.92% payout ratio. Yeah, that number scares a lot of people away.
I mean, a 276% payout ratio is the mathematical equivalent of trying to pour three gallons of water out
of a one gallon jug. By traditional accounting standards, they are bleeding out. How is this company
not totally bankrupt? It looks deeply alarming until you understand the underlying mechanics of
how real estate accounting works. Traditional payout ratios and PE ratios are calculated using earnings
per share or EPS. But for real estate companies, the IRS requires them to deduct a massive non-cash
expense for the depreciation of their physical properties. Ah, so the tax rules mandate that they
claim their buildings are losing value and deteriorating every single year? Exactly. That massive
deduction nukes their earnings on paper. But in the real world, that physical grocery store or
pharmacy isn't losing value. It's likely appreciating. And the tenant is absolutely still paying their
monthly rent in full. So the depreciation is just an accounting fiction. Yes. And the accounting
fiction that drags down EPS, which in turn wildly inflates the payout ratio on basic financial websites.
The actual reliable metric you must use for a read is funds from operations or FFO.
And what does FFO do differently? FFO takes that net income and adds the depreciation right back
in to show the actual cash the business is generating from its operations. When you look at real T income
through the lens of FFO, their 5.2% dividend is completely and comfortably covered by cash flow.
Okay, that makes so much more sense. The source material also points out that real T income has a
low beta of .77. Now for our listeners, beta simply measures how wildly a stock swings compared to
the broader market. A beta of less than one means it is significantly less volatile, less reactive
to the daily panic of the S&P 500. It acts as a low volatility anchor, which makes it highly
attractive for investors trying to sleep well at night while collecting monthly income. A 5.2%
monthly yield from a low volatility anchor is comforting. But you know, human nature is a powerful
thing. If someone is staring down a massive income gap, they often find themselves tempted to push
the limits. They start hunting for double-digit yields. Oh, it happens all the time. So let's explore
the extreme high yield edge of the dividend spectrum. We have data on a very specific subset of assets,
four closed-end funds or CEFs that are currently yielding over 12%. And the hook that draws
investors in is that none of these four specific funds have ever cut their distributions. We're looking
at THW, B-I-T, THQ and PCN. Let's run through the roster. First is THW, the Aberdeen World Health
Care Fund. It yields over 12% and has paid a perfectly flat 11.67 cents per share every single
month for 11 years. Never cut. Never cut, though it's never been raised either. But to generate
that kind of yield, they are heavily exposed to equities holding 80% in stocks, including some highly
speculative French biotech startups like MDVACs. Then you have B-I-T, the BlackRock multi-sector
income trust. It boasts a track record of over 13 years without a cut, also yielding north of 12%.
But their methodology is very different. They use 32% leverage to hold high yield corporate
debt and agency mortgages. Okay, we also have THQ, which is essentially a sister fund to THW,
but much more focused on United States equities. It holds more recognizable, large cap names and
generally offers a better total return. And finally, there is PCN, a PMCO fund that has
actually been operating for 25 years. It focuses on shorter term international debt. But PMCO funds
are notoriously opaque. You are essentially placing blind trust in their management team's ability
to navigate non-public company bonds and derivatives. The variety of strategies is notable, but they all
share that irresistible 12% yield. But listen, there is no free lunch in finance. If the broader
market yields 1.5%, and these funds are handing out a 12% yield that never ever goes down,
they have to be cannibalizing something else to make that math work. What is the structural catch here?
The catch is entirely structural, and it is vital to understand. The first hidden cost is
NEV erosion, meaning the net asset value. The underlying principle of the fund slowly bleeds out
over time. Wait, so your initial investment shrinks? Yes. To maintain the illusion of a massive
uncut dividend, these funds will often simply return portions of your own invested capital back
to you and call it a yield. You feel wealthy getting the payout, but the actual foundation of your
investment is shrinking. Wow, you're eating your own seed corn. Precisely. The second catch is
extreme rate sensitivity. Funds holding agency mortgages, which are mortgage-backed securities guaranteed
by the government, suffer immensely when interest rates rise rapidly. Because the value of those underlying
lower yielding mortgages plummets. Exactly. And what about the leverage aspect? You mentioned BIT is
using 32% leverage. Leverage is the third massive risk. These funds borrow money at short-term
interest rates to buy higher yielding longer term debt, and they pocket the spread. Which works
beautifully in a low rate environment. Right. But when borrowing costs spike, that spread completely
collapses. Furthermore, leverage amplifies everything. It pushes the yield up to 12%, but if the underlying
assets drop in value, those losses are magnified just as violently. So synthesizing all of this for
the investor, these 12% closed-end funds are absolutely not your VOO style core wealth buildings.
No, definitely not. You do not use these as the engine of your vehicle. These are highly specific,
high-risk income supplements. They are the financial equivalent of a tire patch kit meant only to plug
specific immediate holes in a cash flow strategy when you absolutely require high yield income today.
And you're willing to sacrifice your underlying principle to get it. Exactly. You must clearly
define what specific job each asset is performing in your portfolio. A CEF is not a blue chip and a
blue chip is not the S&P 500. Let's remind ourselves of the journey we just took through the sources.
We started with the foundational compounding engine of VOO turning small, consistent investments into
massive wealth over decades. We explored the survival tactics of 1973, learning firsthand that
structured income cash reserves and options act as the vital shock absorbers during a crisis.
And we analyzed the bedrock of those strategies through the cash flow resilience of PNG and
Sonofi's pipeline. Right. We navigated the strategic structural hedges of Goldman's energy picks
and finally we explored the high yield edges of read accounting and the dangerous allure of closed
end funds. It's just a really comprehensive look at how a portfolio functions under different
conditions. And for listeners who want to explore how these mechanics operate in real time,
Cameron May is actually hosting a live stream today, April 2nd, focused specifically on investing
in dividend stocks. Oh, that's perfect timing. Yeah, it's a brilliant resource for seeing these
principles applied practically. That is absolutely worth checking out. Well, we have covered an immense
amount of ground today, but we want to leave you with one final provocative thought to mull over.
We spent a lot of time talking about how building a dividend fortress truly decouples your
lifestyle from the stock markets daily ticker, just like those retirees who survived the 1973
bear market without panic selling. Right. If you take the time to build a financial vehicle with
the right suspension to handle any terrain, does obsessively checking your portfolios total return
every single day actually do more harm than good to your psychological wealth. Oh, man,
that really is the ultimate question of investor psychology. Once the structure is built,
you kind of have to just let it do its job. You really do. Thank you so much for joining us for Episode 31
of The Deep Dive. Drive safe out there, and we will catch you next time.