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How Dividends Change the Game for Merck Shareholders

Anders Bylund
November 20, 2013

The wealth-building power of compound interest will never cease to amaze me. It's a story of patience and attention to detail, where small, short-term differences add up to massive divergence over decades. And in the end, the biggest winners don't always deliver the fattest share-price returns.

Today, I'm taking a look at one of the most generous dividend yields among the 30 Dow Jones (DJINDICES: ^DJI) blue-chip components. Say hello to pharmaceuticals veteran Merck (NYSE: MRK) and its current 3.6% dividend yield.

That figure places Merck just below the Dow's two telecoms in terms of dividend generosity, virtually tied for third place with Intel (NASDAQ: INTC). It's certainly a strong payout, but that doesn't make Merck a no-brainer choice for income investors. Merck's dividend policy comes with some serious flaws.

This chart will show you the two most serious red flags that hover over Merck's dividend policies:

MRK Dividend Chart

MRK Dividend data by YCharts

Infraction No. 1: Merck isn't really into growing its dividends. The size of its quarterly checks flatlined for nearly a decade, and they have only increased by 13% in the last couple years.

Infraction No. 2: Merck really can't afford to raise its dividend payouts. The company already spends more on these distributions than it collects in net earnings. It's the third highest such ratio on the Dow -- behind AT&T and Verizon --  and this is a case of small numbers beating big ones.

The picture changes if you move from non-generally accepted accounting principles earnings to consider the divid