The principle of the strategy seems sound enough: Buy a basket of high-yielding blue chip stocks and then leave them alone to ripen for a few (or many) years.
The reality of the strategy, however, might prompt you to try a slightly different tack… one that’s a little less mechanical, and a little more subjective. Here’s why.
Breaking down the Dow’s highest-yielding dividend stocks
Don’t misunderstand. Screening the market for potential stock picks by using criteria like dividend yields, valuations, and growth rates is a great way to start your search. It’s not necessarily where your search process should end, though. At the end of the day, you’ll want to make an educated judgment call about the merits of any company’s stock. That includes the blue chip names that make up the Dow Jones Industrial Average (^DJI -0.32%).
In fact, most of the Dow’s highest-paying dividend stocks right now are tough to justify buying when there are so many other, better choices out there.
Take Walgreens Boots Alliance (WBA 1.40%) as an example. Its 9% yield at current share prices is the highest among the Dow constituents. That’s an incredible payout — but the yield is high, and the stock is cheap, for a reason.
The company is facing complicated struggles in an incredibly competitive environment. While the board’s decision to name pharmacy veteran Tim Wentworth as Walgreens’ new chief executive officer earlier this month was probably the right move in the long run, it was also arguably long overdue. Wentworth is taking the helm of an organization facing lots of problems, not the least of which is high costs that need to be trimmed. The idea of a dividend cut in the meantime — even if only temporarily — continues to circulate a bit too freely among the knowledgeable pros on Wall Street.
Such a cut would, of course, negate the reason income-seeking investors might want to own this stock.
Industrial giant 3M (MMM -0.81%) presents a similar conundrum for would-be shareholders. At its current share price, the stock’s dividend yield of 6.7% is nothing short of amazing. But it’s also in jeopardy.
Although the company delivered third-quarter profits of $2.68 per share — topping estimates of $2.34 per share — and then went on to raise its full-year earnings forecast, the settlements of lawsuits by U.S. military veterans related to its faulty earplugs are costing it $6 billion. And settling its other lawsuits over PFASs — also known as “forever chemicals” — looks likely to cost it upward of $10 billion. While these payments will be spaced out over the next several years, they’re ultimately going to largely be paid in cash. 3M’s dividend is therefore threatened, even if only indirectly as those expenses will limit the company’s ability to invest in its own growth.
Perhaps the only top-yielding Dow Jones Industrial stock worth picking up right now is wireless service provider Verizon (VZ -1.78%).
Its dividend yield of nearly 8% is seemingly too high to be true. But it’s that high mostly because investors have been underestimating the company’s growth and income prospects for years. Shares are currently trading in the same range that they were all the way back in 2010, even though its bottom line has more than quadrupled during that time, and its quarterly dividend payment has grown from $0.48 per share then to $0.66 per share now.
And the stage is set for more of the same. Verizon just delivered third-quarter earnings that topped estimates, and outperformed its subscriber growth estimate, too, prompting the wireless outfit to raise its full-year free cash flow forecast by $1 billion to at least $18 billion.
Before you buy any dividend-paying stock for its dividend…
The point is, there’s always more to the story than just a sky-high dividend yield. In fact, you should be a bit suspicious when a stock’s dividend yield is leaps and bounds ahead of its peers’ payouts — even if it’s a quality blue chip stock. Investors may be pricing in trouble they see on the horizon, or pricing in a dividend cut they feel sure is coming.
With that said, here are five questions you’ll want to ask yourself before buying any dividend stock, regardless of how high or low the yield may be at the time.
- Is this dividend at risk of being cut?
- If the yield is abnormally high because the stock is performing poorly, what are other investors seeing or not seeing about the company’s future?
- How much and how reliably has this stock’s dividend payment been raised previously?
- Does this company provide something that will always be in demand?
- Will I also want/need capital appreciation from this stock, and can the underlying organization provide it in addition to its dividend income in the meantime?
Legitimate, honest answers to those questions may help you steer clear of dividend disappointments. They may also point you toward some great dividend payers you wouldn’t have otherwise considered buying.
In the meantime, the only one of the Dow’s three highest-yielding dividend stocks that passes that five-question test right now is Verizon.
James Brumley has no position in any of the stocks mentioned. The Motley Fool recommends 3M and Verizon Communications. The Motley Fool has a disclosure policy.