Because of how it's configured and because it only has 30 components, the Dow Jones Industrial Average(DJI) (DJIA) isn't considered as good a measure of the broader stock market as the S&P 500 or the Nasdaq Composite. However, the DJIA still embodies reliability and industry leadership. For that reason, the DJIA can serve as a great starting point for investors searching for quality dividend stocks.
Out of the 30 components in the Dow Jones Industrial Average, the chemical company Dow (DOW), Verizon Communications (VZ), 3M (MMM), and Walgreens Boots Alliance (WBA) are the only four stocks with dividend yields above 5%. The 5% yield threshold has become increasingly important of late given that the 10-year Treasury rate 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 high-yield stock in the DJIA to buy now.
Dow has a Rock-Solid Underlying Business
Dow the chemical company shouldn't be confused with the “Dow,” the common name for the Dow Jones Industrial Average. Dow is the product of a spin-off from DowDuPont in 2019, with Dow getting to remain in the Dow Jones Industrial Average while DuPont and Corteva became independent companies that are not members of the index.
Out of the 30 components in the DJIA, commodity chemical company Dow may be one of the best sources of passive income. Dow combines a high dividend yield with a strong underlying business, which is far different from the other high-yield stocks in the DJIA.
However, if you look at Dow's performance as of late, it's easy to see why the stock has been under pressure and is down since the spin-off.
Dow's stock price was on the rise as its earnings and revenue were peaking. But Dow's earnings tend to fall when the economy slows, which is exactly what is happening — and now demand in Dow's core end markets is under pressure. Dow is also facing higher input costs, due in part to higher oil prices.
But Dow is just experiencing a different phase in its usual cycle, which has nothing to do with the strength of the underlying business. And most importantly, Dow used the higher earnings over the last few years to bolster its balance sheet.
Dow Wins When It Comes to Financial Health
A strong balance sheet is an essential quality of top dividend-paying companies, because it provides the wiggle room needed to support dividend payments, acquisitions, or capital investments even when there's a downturn in the business cycle.
Dow has spent the last few years reducing its dependence on debt, which lowered its debt-to-capital ratio (D/C) to 42.8% and its financial debt-to-equity (D/E) ratio down to just 0.39 — both of which are excellent.
Like Dow, Walgreens also has a low D/C and D/E ratio. 3M's D/C ratio has been on the rise. Unlike D/E, D/C takes into account total debt and shareholder 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 entire market capitalization of the company. Years of overinvestment have riddled the company's balance sheet with debt, which severely damages the investment thesis for Verizon despite its 8.7% dividend yield.
Fundamentals are Under Pressure for Walgreens and 3M
But the issue 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 sported a 5% or so operating margin.
It wasn't a great business, but Walgreens was able to steadily grow earnings over the years. But despite earnings growth, its operating margin has been steadily declining. And recently, earnings and operating margin turned negative as Walgreens stock is near a 25-year low.
Meanwhile, 3M has been battling some major legal issues, which have cost billions in settlements. Aside from these headwinds, 3M's growth has also been slowing for years. So it faces a one-two punch of operational challenges and non-recurring expenses.
Both Walgreens and 3M could stage epic turnarounds and prove to be excellent investments given how much each of their stock prices got clobbered. But it remains a cloudy outlook only worth pursuing for investors who understand these businesses well and are comfortable with the risks.
Dow Checks the Boxes of a High-Yield Dividend Stock Worth Owning
What separates Dow from the other high-yield dividend stocks in the DJIA is that the business is sound, and the balance sheet is in excellent shape. The only thing going against Dow is the business cycle, but this has nothing to do with management errors or execution blunders.
The last thing investors want to do is pile into a high-yield dividend stock only to have the capital losses exceed the dividend gains. Dow remains an industry-leading business that is more than capable of navigating the market cycle. And for that reason, Dow stock and its 5.6% dividend yield are worth a closer look.
Originally published on Fool.com