Merck vs. Verizon: Which Dow Stock's Dividend Dominates?

Dividend stocks outperform non-dividend-paying stocks over the long run. It happens in good markets and bad, and the benefit of dividends can be quite striking -- dividend payments have made up about 40% of the market's average annual return from 1936 to the present day. But few of us can invest in every single dividend-paying stock on the market, and even if we could, we might find better gains by being selective. That's why we'll be pitting two of the Dow Jones Industrial Average's (DJINDICES: ^DJI  ) dividend payers against each other today to find out which Dow stock is the true dividend champion. Let's take a closer look at our two contenders now.

Tale of the tape
Merck (NYSE: MRK  ) was the Dow's first pure-play pharmaceutical company when it joined the index 33 years ago. The New Jersey-based drugmaker might just have the most ancient roots of any Dow component, as it traces its origins to 1668, when namesake Friedrich Merck acquired a drugstore in Germany. However, it wasn't until after a 1953 merger with American drugmaker Sharp & Dohme that Merck began to resemble the modern multinational pharmaceutical manufacturer today's investors know and love. Since that merger, Merck has grown to become the third-largest pharmaceutical company in the United States by revenues.

Verizon (NYSE: VZ  ) might not have the same long-term pedigree, but its history can be traced back to 1876, when Alexander Graham Bell first patented the telephone. Verizon is made up of several major chunks of the former Bell System that eventually reassembled after its 1984 divestiture, as well as some independent holdouts that eventually succumbed to merger pressure. The New York City-based telecom giant consistently battles the Dow's other telecom giant for dominance of the American market, a contest in which Verizon narrowly finished second last year. Verizon's wireless venture, however, is still the top American wireless provider, with over 115 million subscriptions at the end of the 2012 fiscal year.

Statistic

Merck

Verizon 

Market cap

$146.6 billion

$149.6 billion

P/E Ratio

24.8

126.6

Trailing 12-month profit margin

13%

1%

TTM free cash flow margin*

17.8%

11%

Five-year total return 

65.7%

104.1%

Source: Morningstar and YCharts.
*Free cash flow margin is free cash flow divided by revenue for the trailing 12 months.

Our two combatants might have very similar market caps, but it looks like Merck is a better bargain thanks to its superior free cash flow margin. Will the results bear out this assumption? There's only one way to find out ...

Round one: endurance
Merck has been paying dividends without interruption since 1970. That would earn it an easy victory over Verizon, which traces its direct corporate lineage back to 1984. However, it's certainly possible that a number of Verizon shareholders originally held shares in the Bell System, which has a history of dividend payments stretching back to 1893. When it comes to longevity, it's hard to beat more than a century of payouts, even if most of those payouts were made by a monopoly broken by an antitrust suit.

Winner: Verizon, 1-0.

Round two: stability
Paying dividends is well and good, but how long have our two companies been increasing their dividends? The same dividend payout year after year can quickly fall behind a rising market, and there's no better sign of a company's financial stability than a rising payout in a weak market (as long as it's sustainable, of course). Verizon has been increasing its payouts every year since 2004, which is more than enough time to beat Merck -- before boosting its payout at the end of 2011, Merck had actually been keeping its payout at the same level since 2004.

Winner: Verizon, 2-0.

Round three: power
It's not that hard to commit to paying back shareholders, but are these payments enticing, or merely tokens? Let's take a look at how both companies have maintained their dividend yields over time as their businesses and share prices grow:

MRK Dividend Yield Chart

MRK Dividend Yield data by YCharts

Winner: Verizon, 3-0.

Round four: strength
A stock's yield can stay high without much effort if its share price doesn't budge, so let's look at the growth in payouts over the past five years. If you bought in several years ago and the company's grown its payout substantially, your real yield is likely look much better than what's shown above.

MRK Dividend Chart

MRK Dividend data by YCharts

Winner: Merck, 1-3.

Round five: flexibility
A company -- even one as well-positioned as these -- needs to manage its cash wisely to ensure that there's enough available for tough times. Paying out too much of its free cash flow in dividends could be a warning sign that the dividend is at risk, particularly if business weakens. This next metric analyzes just how much of their free cash flows our two companies have paid out in dividends over the past four quarters:

MRK Cash Div. Payout Ratio TTM Chart

MRK Cash Div. Payout Ratio TTM data by YCharts

Winner: Merck, 2-3.

Despite a valiant late-game effort, Merck comes back too late to take top honors. You could argue that Merck deserves the point for endurance, but that isn't an argument I'd want to have with any dedicated long-term Ma Bell shareholders. Do you think Merck got the short end of the stick today? Will pills beat cell phones for shareholders in the end? Let me know if you agree or disagree with these results by leaving a comment below.

If you're an investor who prefers returns to rhetoric, you'll want to read The Motley Fool's new free report "5 Dividend Myths ... Busted!" In it, you'll learn which stocks provide premium growth and whether bigger dividends are better. Click here to keep reading.


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