At a stock price of around $25 a share, Walgreens Boots Alliance (WBA 0.57%) is the lowest-weighted component of the price-weighted Dow Jones Industrial Average. But years of dividend raises paired with an underperforming stock price helped propel Walgreens' dividend yield to nearly 10% in late November, when the stock was selling off with no end in sight.
At the time, Walgreens was the highest-yielding stock in the Dow and briefly surpassed Altria Group as the highest-yielding stock in the entire S&P 500. That all changed on Jan. 4, when Walgreens announced a 48% dividend cut, reducing the quarterly payout from $0.48 a share to $0.25.
In an instant, Walgreens lost its crown as the highest-yielding Dow stock. Today, its forward yield is around just 4%, which is still far higher than the average yield in the S&P 500 or Dow but a far cry from the status it used to enjoy.
Let's reflect on how Walgreens got here, why it cut its dividend, and what investors can learn from this to make wise decisions.
Image source: Getty Images.
An abysmal performance
Over the last 20 years, Walgreens stock is down 30%, even after the recent rally over a month or so. When factoring in dividends, it is only up 12.4% compared to a 528.7% total return in the S&P 500.
The following chart is disappointing. Years of dividend raises were wiped away, paired with the backdrop of a poor-performing stock price.
The wrong way to become a Dividend King
Red flags were leading up to this moment. In the early 2000s and even the early 2010s, Walgreens made sizable dividend raises yearly. But over the last five years or so, management was making minimal raises -- just $0.01 or $0.02 per share per quarter (or even less).
Companies sometimes make minimal raises to continue their streak of consecutive dividend increases (I'm looking at you, 3M). Walgreens had raised its dividend for 47 consecutive years.
Just three more years would have given it the coveted Dividend King status, putting it on an elite list of companies that have paid and raised their dividends for at least 50 consecutive years. But labels can be deceiving.
Other Dividend Kings, like Procter & Gamble or Illinois Tool Works, use higher earnings to fund dividend raises and are not just raising them to appease investors. And because earnings are growing, the market views both businesses as more valuable, which is why both stocks have done well over the long term.
Walgreens tried to achieve the Dividend King distinction by raising its payout despite a languishing business and an underperforming stock price.
Valuable lessons
Walgreens' recent dividend cut reminds investors of a few key lessons. First, a dividend is only as strong as the underlying business. And the ability to sustainably raise dividends over time depends on operational performance, not making the minimal raise to try to achieve a certain distinction.
Another lesson is that a high yield doesn't tell the full story. In the case of Walgreens, investors holding the stock for the last 20 years would have underperformed the risk-free rate even when factoring in dividends and missed out on an incredible growth period in the broader market.
Many Dividend Kings have a yield of 3% or less. But that's partly because the stock prices of top Dividend Kings go up as much or more than the growth rate of the dividend.
For example, Illinois Tool Works' stock is up over 86% in the last five years compared to a 40% increase in the dividend, while P&G is up 48.5% and its dividend is up 26.1%. Because both stock prices are up by more than the dividend has increased, the yield is lower today than it was five years ago.
In this vein, viewing the yield in a vacuum is a big mistake because it can overly reward underperforming stocks and punish well-performing stocks. By comparison, Walgreens stock is down by more than 65% in the last five years. And after the recent cut, its dividend is down 43.2%.
So ultimately, Walgreens' brief stint with the highest yield in the Dow and the S&P 500 meant very little, as investors would have been better off in cash over the last five years than collecting a dividend from a falling knife like Walgreens.
Avoid the allure of a high yield
No matter your risk tolerance or investment time horizon, it's important not to pass on an excellent company and instead go for a not-as-good company just because it has a higher yield.
Focusing on the business itself -- how it is doing, where it is going, and if future dividend raises are feasible -- is a better use of your time than trying to juice your portfolio with a bit of extra passive income.
