In a year when all three of the major stock indexes in the United States have declined by 15% or more, there are plenty of dividend stocks out there with high dividend yields. However, a large number of these are low-quality companies with declining fundamentals where the dividend yield isn't sustainable, making them best to avoid.
Yet investors looking for eye-popping dividend yields from high-quality companies are in luck. What if I told you that there is a Dow Jones Industrial Average stock with a yield north of 6%? Dow Inc. (DOW -0.29%), a maker of various chemical products and one of the Dow Jones Industrial Average's 30 components, fits this description.
Let's take a look at it and why it looks like a buy right now.
An exclusive club
Dow Inc. is a $30 billion company that primarily engages in the commodity chemicals business. Its three business segments are packaging and specialty plastics, industrial intermediates and infrastructure, and performance materials and coatings. The company came into its current incarnation as the result of a 2017 merger between and DuPont de Nemours and a subsequent move that saw the company split into three separate companies, which birthed Dow Inc.
The exclusive Dow Jones Industrial index essentially screens out low-quality companies as it is an index of 30 of the top blue-chip stocks in the United States. S&P Global, the company that now compiles the Dow Jones Industrial Average, says that companies in the exclusive index must be profitable at the time of admission, must meet all of the criteria for being in the S&P 500, and can make it into the club "only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors."
While those criteria are admittedly somewhat vague and Dow components are by no means infallible, investors can at least feel good about the fact that Dow Inc. is considered worthy of this membership among some of the top blue-chip companies in the world.
Rock bottom valuation
Shares of Dow Inc. trade at a rock bottom valuation. To be clear, Dow is not without its challenges -- the surge of oil and natural gas prices is not great for companies like Dow as these are key inputs for making plastics. The company also has a lot of debt as a result of the spinoff. Chemical companies are viewed as cyclical and investors who are worried the economy could be heading into a recession are reluctant to own cyclical stocks.
But Dow has been paying down debt while oil and natural gas prices have fallen from their highs this summer and at a valuation of just five times earnings, these challenges seem to be more than accounted for in the stock's inexpensive valuation.
A cheap valuation can often be a sign of a stock with declining earnings, but since the spinoff, Dow has grown earnings before interest, taxes, depreciation, and amortization (EBITDA) from $8.2 billion to $9.3 billion on a three-year average basis, and also increased free cash flow, while reducing debt and the number of shares outstanding (through share buybacks).
Dow Inc.'s dividend yield of 6% trounces the market average and is an attractive proposition for income investors. Since the spinoff, Dow's dividend has remained steady at $0.70 a quarter. While the dividend has not grown since then, the company also deserves credit for maintaining this dividend during a challenging 2020 and 2021 that saw many companies cut or suspend their dividends.
Furthermore, the $2.80-per-share annual dividend is well covered by the company's $8.93 per share in earnings, which gives Dow Inc. a dividend payout ratio of just 31%. This is very sustainable payout ratio and also means that Dow has the flexibility to increase its dividend payout in the future.
Is Dow Inc. a buy?
Dow Inc. is a large, diversified business with a global presence and operations across a variety of business segments and end markets. While it is contending with some challenges, it is rare to find a high-quality Dow Jones component trading at this low of a valuation and with this high of a dividend yield. Dow's inexpensive valuation and dividend yield of over 6%, which is sufficiently covered by the company's earnings, make it an attractive buy for income investors.