Because of how it is configured and because there are only 30 components, the Dow Jones Industrial Average (^DJI -0.86%) (DJIA) is not considered as good a measure of the broader stock market as S&P 500 or Nasdaq Composite. However, the DJIA still represents reliability and industry leadership. For this reason, the DJIA can serve as a great starting point for investors looking for quality dividend stocks.
Of the 30 components in the Dow Jones Industrial Average, the chemical company Dow (DOW -0.93%), Verizon Communications (VZ -0.03%), 3M (Mmm -0.59%)and Walgreens Boots Alliance (WBA 1.43%) are the only four stocks with a dividend yield above 5%. The 5% yield threshold has become increasingly important recently, given that the 10-year Treasury yield is 4.7%.
Here’s what Dow is doing right, what the other three companies are doing wrong, and why Dow stands out as the best DJIA high-yield stock to buy now.
Dow has a solid core business
The Dow Chemical Company should not be confused with “Dow,” the common name for the Dow Jones Industrial Average. Dow is the product of a spin-off from DowDuPont in 2019, with Dow remaining in the Dow Jones Industrial Average while DuPont and Corteva became independent companies that are not members of the index.
Of the 30 components in the DJIA, the Dow Chemical Company may be one of the best sources of passive income. The Dow combines a high dividend yield with a strong underlying business that is far different from other high-yielding stocks in the DJIA.
However, if you look at the Dow’s recent performance, it’s easy to see why the stock has been under pressure and down since the split.
The Dow’s stock price rose as its earnings and revenue peaked. But Dow earnings tend to fall when the economy slows, which is exactly what’s happening — and now demand in the Dow’s major end markets is under pressure. Dow also faces higher raw material costs, due in part to higher oil prices.
But the Dow is simply experiencing a different phase in its usual cycle that has nothing to do with the strength of the underlying business. And most importantly, the Dow has used the higher earnings of the past few years to strengthen its balance sheet.
The Dow wins when it comes to financial health
A strong balance sheet is an essential quality of the best dividend paying companies because it provides the wiggle room needed to support dividend payments, acquisitions or capital investments even when there is a downturn in the business cycle.
The Dow has spent the past few years reducing its reliance on debt, which has reduced its debt-to-equity (D/C) ratio to 42.8% and its financial debt-to-equity (D/E) ratio to just 0.39 — and both are excellent.
Like the Dow, Walgreens also has a low D/C and D/E ratio. 3M’s D/C ratio is rising. Unlike D/E, D/C takes into account total debt and equity, not just total debt. Verizon has a high D/C and D/E ratio. Verizon has more total net long-term debt than the company’s entire market capitalization. Years of overinvestment have left the company’s balance sheet riddled with debt, seriously hurting the investment case for Verizon despite its 8.7% dividend yield.
Fundamentals are under pressure for Walgreens and 3M
But the problem for Walgreens and 3M isn’t their balance sheets — it’s the state of their businesses.
In the mid-2000s, Walgreens was a profitable business that had about a 5% operating margin.
It wasn’t a great business, but Walgreens was able to steadily grow its revenue over the years. But despite the growth in profits, its operating margin has steadily declined. And recently, earnings and operating margin have turned negative as Walgreens shares near 25-year lows.
Meanwhile, 3M is battling some major legal issues that are worth billions in settlements. Besides these headwinds, 3M’s growth has also been slowing for years. So it faces a one-two punch of operational challenges and one-time costs.
Both Walgreens and 3M could make epic turnarounds and prove to be excellent investments given how much their stock prices have each fallen. But it remains a murky prospect worth pursuing only for investors who understand these businesses well and are comfortable with the risks.
The Dow checks the boxes for a high-yielding dividend stock worth owning
What sets the Dow apart from other high-yielding dividend stocks in the DJIA is that the business is stable and the balance sheet is in excellent shape. The only thing going against the Dow is the business cycle, but that has nothing to do with management mistakes or execution blunders.
The last thing investors want to do is pile into high-yielding dividend stocks only to have capital losses outweigh dividend gains. The Dow remains an industry-leading business that is more than capable of navigating the market cycle. And for that reason, Dow shares and their 5.6% dividend yield are worth a closer look.