The Dow's Scariest Dividend

Dividend stocks have realized a resurgence of investor interest the past few years, and with good reason. With the markets continuing their unpredictable and volatile swings, who wouldn't want a little extra guaranteed return?

Evidence continues to show that dividend-paying equities are among the best wealth-building vehicles out there.  

Of course, that doesn't mean we should all run out and buy the first high-yielding dividend stock we can. Since a dividend is only as good as the company that backs it, we have to do a little more digging first.

One place many start is the Dow Jones Industrial Average (INDEX: ^DJI  ) . The index is composed of 30 blue-chip stocks, a category defined by their financial soundness. And considering more than half of the companies have been registered on the Dow for two decades or more, you can sleep soundly knowing they're here to stay.

However, just because a company has been around for a while, that doesn't mean their dividends are guaranteed. Take a look at General Electric (NYSE: GE  ) , for example. The company is the oldest Dow component, yet it lost its coveted dividend aristocrat status in 2009, when it slashed the dividend from $0.31 to $0.10 per share.

With that in mind, I tested the Dow components with a payout ratio greater than 50% and compared their 5-year payout ratio growth to their net income growth to see whether their dividend payments were accelerating faster than the money they booked.

Company Name

Dividend Yield

Payout Ratio % (LTM)

5-Year Payout Ratio Growth (LTM)

5-Year Net Income Growth

Merck (NYSE: MRK  ) 4.3% 111.2 70% (18%)
Johnson & Johnson (NYSE: JNJ  ) 3.5% 53.4 41% 3.7%
Kraft 3% 63.2 32% 0.9%
AT&T 5.8% 86.3 24% 53%
Verizon 5.1% 78.1 15% 3.5%
Pfizer (NYSE: PFE  ) 4% 54.6 5% (9.6%)

Source: S&P Capital IQ.

The first thing that jumps out at me on this list is Merck. The company has a payout ratio of 111% and it's grown its payout ratio 70% over the past five years despite an 18% retraction in net income over the same period. This doesn't actually mean it grew its dividend, though. The biggest reason is that the company maintained a roughly $0.38 dividend for the past five years despite a decline in net income. Although it has an appealing 4.3% yield, I think it's fair to call it the shakiest dividend on the Dow. Its weak five-year performance isn't encouraging, either.

Next up is Johnson & Johnson. The company just qualifies for the greater-than-50% payout-ratio cutoff and has the second highest payout growth on the list at 41%. That's more than 10 times its net income growth over the same period. This isn't very encouraging, but its current payout ratio is still the second lowest on the list and its yield doesn't seem out of control. One reason for the spread is that J&J is probably trying to maintain its dividend aristocrat status, and to do so it must continue raising dividends each year. Johnson & Johnson is probably still a good long-term bet, but if you're dividend-fishing on the Dow, I think there are safer and better dividends.

The other company that struck me on this list was Pfizer. Much like GE, Pfizer had to dramatically cut its dividend in 2009 and lost its dividend aristocrat status. That's one of the reasons its payout-ratio growth is so low, which is good considering the retraction in net income over the same period. By contrast, Merck kept its dividend intact over that time and now sports the shakiest dividend on the Dow.

Even though the Dow is full of known, stable companies, I like to run a test like this every now and again to see where the strong or weak links are on the index. While I truly think the Dow components are some of the best companies out there, some are still better than others. For dividend investors eyeing the Dow right now, I'd steer clear of Merck.

Even better dividends?
The Dow does house some great dividends, but with only 30 components it's limited in its offering. If you're looking for even more dividend picks, I invite you to read The Motley Fool's special free report: "Secure Your Future With 11 Rock-Solid Dividend Stocks." Our analysts have outlined their favorite dividend stocks to reward shareholders for years to come. The report is free today, but won't be forever, so access your copy now.

Austin Smith owns shares of Pfizer. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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