At the start of the new year, many investors might think about the “Dogs of the Dow” investment strategy, which involves purchasing the 10 highest-yielding stocks in the Dow Jones Industrial Average on the first trading day of the year. The returns of this strategy are mixed — some years, it beats the index, and in others, it doesn’t (it beat the index in 2022).
While we won’t be looking at all 10 Dogs of the Dow stocks today, we’ll focus on the three highest-yielding ones — Verizon Communications (VZ 1.18%), Intel (INTC 4.25%), and Dow (DOW 3.99%) (the chemical company, not to be confused with the index). With these three, investors can capture some very high-yielding stocks, with the lowest paying a fantastic 6.5% dividend.
So are these stocks suitable investments? Or is the above-average dividend just luring in unsuspecting investors? Let’s find out.
Sporting the highest dividend yield among its peers, Verizon yields 6.5%. With a yield that high, some investors might worry the telecom giant may not be able to fund its dividend.
A straightforward calculation to determine this is its dividend payout ratio, basically the dividend divided by a profit metric (usually net income or free cash flow). Verizon’s payout ratio is 56% when calculated using its earnings and 60% when free cash flow is used. Both are healthy payout ratios.
So why is the dividend so high? Because Verizon’s stock price fell nearly 25% in 2022, it decreased the denominator of the dividend yield formula, exaggerating its yield. While there are many reasons Verizon’s stock fell in 2022, the biggest reason is rising interest rates.
Because Verizon funds a lot of growth with debt, new, higher-interest debt will be more expensive, either straining Verizon’s finances or limiting its expansion potential. Either way, this could present an issue for Verizon in 2023. While I think the dividends are safe, a falling stock price will destroy value quicker than dividends can create it. So although the yield is tempting, there may be better places to invest than Verizon.
The second-highest yielder is Intel, at 5.6%. Similar to Verizon, its tumbling stock price (down nearly 50% in 2022) exaggerated its dividend yield. However, Intel also has some demand problems it is sorting out.
In its third-quarter earnings report, management noted that the chip industry is experiencing a cyclical slowdown impacting the personal computing market. However, its data center and artificial intelligence group also experienced falling revenue (down 27%), so there may be more to this picture.
Falling revenue caused Intel to report negative free cash flow, so it burnt money in the quarter, meaning it had to pay its dividend from its balance sheet — a bad sign. With its quarterly dividend sitting at $0.365 per share, it also exceeds its Q3 earnings per share (EPS).
That’s not a good look for any stock that pays dividends, and Intel may need to slash its dividend to compensate for the current environment. Until it can produce positive free cash flow, Intel likely isn’t a great dividend stock if you’re counting on the 5.6% yield to be there.
Dow is the third-highest-yielding stock in the index, with a slightly lower yield than Intel at 5.5%. The company is one of the world’s biggest producers of plastics, chemicals, and agricultural products, making it vital for the global economy.
The problem is that Dow’s processes are energy-intensive and utilize fossil fuels, which have increased significantly in price. This was a critical factor in Dow’s Q3 EPS falling to $1.02 from $2.23 last year. Additionally, the company experienced sales pressure in many markets, causing its revenue to decrease.
However, Dow’s stock didn’t suffer as badly as the other two in 2022, as it was only down 11%. Additionally, the company is producing massive free cash flow (FCF), with its FCF dividend payout ratio coming in at 35.1%.
Although Dow may see some headwinds, its vital essence to the economy makes it a relatively safe stock. Of the three, Dow is probably the best bet if you’re looking for a high-yielding stock. However, it isn’t without its challenges, which could affect the stock price.
Chasing dividend yields isn’t the best strategy. Sometimes, companies have high yields for a reason (and it isn’t a good one). Instead, investors might be better off looking at slightly lower-yielding companies that don’t face the same challenges these three do. But if I had to choose one, Dow seems like the best candidate.
Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Intel. The Motley Fool recommends Verizon Communications and recommends the following options: long January 2023 $57.50 calls on Intel, long January 2025 $45 calls on Intel, and short January 2025 $45 puts on Intel. The Motley Fool has a disclosure policy.