The Dow Jones Industrial Average(DJINDICES: ^DJI) is an odd index in that it only includes 30 companies, and it is weighted by share price. Despite its quirks, it has remained a prominent market gauge over time and is a fairly good and concise starting point if you are looking for stock picks. There's even an entire approach (the Dogs of the Dow) dedicated to using the index to generate a high yield.
But what do you get when you simply pick the highest-yielding Dow stocks? Right now, the top three are Verizon(NYSE: VZ), Dow(NYSE: DOW), and Chevon(NYSE: CVX). A quick look at this trio will show that blindly buying high-yield stocks may not be what you want to do.
1. Verizon is big, important, and heavily leveraged
Verizon is one of the leading telecommunications companies in the United States. Its customer base tends to be fairly sticky, and thus, the monthly payments it collects for the services it provides are annuity-like. However, competition is pretty fierce in the cellular space, so Verizon is basically forced to keep up with the competition at all times, or it risks falling behind and losing customers. Capital investment is a large and constant expense. The stock is yielding a very material 6.3% today, and the dividend has been increased annually for 20 consecutive years.
Why is the yield so high? One reason for this is the expected slowdown in growth. The U.S. telecommunications market is saturated, so most growth will likely come from price increases. Those tend to be small in any given year. But there's another problem here that's been hinted at already. Verizon has to spend lots of money to compete effectively with its largest peers. It has the highest leverage (and thus a relatively reduced latitude for spending) among its closest peers, which increases risk and could hamper future growth prospects.
It probably wouldn't be a mistake to buy Verizon for its high yield. But it is important to understand that the balance sheet will need monitoring, and that growth is likely to be slow, at best. To highlight that point, dividend growth over the past decade was only around 2% a year.
2. Dow's dividend is stuck in neutral
Dow, the company, not to be confused with Dow Jones, the index, is a chemical manufacturer. Chemicals fall into the downstream segment of the energy sector. The energy sector experiences volatility due to the commodity nature of oil and natural gas. Many chemicals are commodities, too.
So, companies like Dow have to deal with volatile input prices and volatile prices for the products they produce and sell. That's a tough backdrop for a dividend-paying company to navigate since revenue and earnings can swing materially from year to year.
Dow has come up with a decent solution. It has set its dividend at a level that it believes is sustainable through the cycle. It has paid a $0.70 per share quarterly dividend since the breakup of DowDuPont in 2019. The dividend yield today is roughly 5.4%. But, given the history, investors shouldn't expect dividend increases anytime soon. That means that the yield will rely entirely on the market perception of the stock, which will probably track along with company performance and industry dynamics. (Or, to put it another way, Dow will have a high yield when investor sentiment is the most negative.)
For most dividend investors, Dow probably won't be that attractive of a choice even though it has a lofty yield. There are equally attractive stocks that offer both yield and the opportunity for dividend growth.
3. Chevron is a survivor in a volatile industry
Chevron also hails from the energy sector, and is one of the largest integrated oil companies on the planet. Being integrated means that it produces oil and natural gas (the upstream), transports energy (the midstream), and processes the commodities (the downstream, which is where Dow operates). Having exposure across the energy landscape helps to soften the peaks and valleys of the energy sector over time, but it doesn't eliminate them.
So investors need to go in expecting a volatile performance, both stock-wise and business-wise. If you prefer boring stocks, Chevron probably won't be a good fit for you despite its attractive 4.3% dividend yield.
That said, Chevron has proven it can ride the swings in the energy sector while continuing to reward investors well along the way. Impressively, it has increased its dividend every year for 37 consecutive years. A key factor here is the company's rock-solid balance sheet. The debt-to-equity ratio is a tiny 0.15 times right now, which would be good for any company. However, that low leverage allows Chevron to take on debt during oil downturns so it can continue to support its business and dividend until oil prices recover (which they have, historically, always done).
If you are looking for an energy stock, Chevron is probably one of the best options for dividend investors. But if you are just looking for stocks with large dividend yields, the fact that Chevron operates in a very volatile sector might turn you off.
More than yield to think about
Verizon, Dow, and Chevron are all solid companies that come with material caveats. Not a single one of them is a simple "buy" decision. Verizon's debt and slow growth are big issues to consider, along with its fat yield. Dow's lack of dividend growth and volatile business have to be taken into consideration along with its yield before making a buy decision. And Chevron's commodity-driven operations are probably even more important to think about than its yield and dividend growth.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.
