Dow Inc.'s (DOW -0.20%) stock price is down 34.2% from its high. The commodity chemicals company now has a price-to-earnings ratio of 5.2, which suggests that investors think earnings will decline and make the valuation look less compelling. 

The low P/E is somewhat surprising, considering that Dow has spent the last few years improving its balance sheet. It also generates plenty of earnings and free cash flow to support its generous dividend. What's more, Dow stock is inexpensive, has a high yield, and is an industry-leading company. All that suggests it might just be a perfect passive income play for long-term investors. 

A person working in a plastic recycling factory.

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A look at the reliability of Dow's dividend 

When Dow spun off from DuPont de Nemours and Corteva in 2019, it paid a $0.70 per share, per quarter in dividends. Since then, it hasn't raised its quarterly payout -- which may be a red flag for income investors who expect consistent annual dividend increases. But with a yield of 6.3%, there's really no pressure for Dow to raise the dividend any time soon -- as the stock already provides a passive income stream high enough to supplement income in retirement.

In fact, I would argue that Dow has made the right decision not to raise its dividend -- choosing instead to use excess profits to pay down debt and ensuring the dividend stays affordable even if profits fall.

Dow's improved balance sheet

Since the spin-off, Dow has substantially improved its financial health. Total net long-term debt is down by a third in a little over three years. And its debt-to-capital ratio and financial debt-to-equity ratio are healthy and at their lowest levels since the spin-off.

DOW Debt To Capital (Quarterly) Chart

DOW Debt To Capital (Quarterly) data by YCharts.

The bear case for Dow just doesn't hold up

The bear case for Dow and its commodity chemical peers is that the industry is entering a sector-wide downtrend that will result in lower growth and compressed margins. Even if that is true, Dow has a lot of things going for it that should position it to outlast a challenging period. And the investment thesis for Dow stock has far more pros than cons.

The investment thesis starts with a strong balance sheet, followed by a dirt cheap valuation. Add in the high, yet sustainable, dividend yield of 6.3% and you get a return many investors hope to earn. 

Dow is also a coiled spring for economic growth. Rising interest rates and economic challenges throughout the developed world cast a bleak short-term outlook. But when the business cycle does turn, Dow is well positioned. The key to investing in cyclical companies is making sure they have what it takes to endure the downturns while also being able to expand production to capitalize on the booms. Dow has these attributes in spades.

In the meantime, there's little doubt that Dow will be able to afford its dividend, seeing as its free cash flow (FCF) per share and earnings per share easily exceed the dividend per share. The payout ratio is a very manageable 31%.

DOW Free Cash Flow Per Share (Quarterly) Chart

DOW Free Cash Flow Per Share (Quarterly) data by YCharts.

Even during the height of the COVID-19 pandemic, which collapsed demand for Dow's commodity chemicals, the company still generated enough FCF to support the dividend. In fact, quarterly FCF per share has only fallen short of the dividend for one quarter in the last three years and has always easily exceeded the dividend on an annual basis.

A reliable dividend stock worth considering now

Dow's strong balance sheet, low valuation, and affordable dividend position it nicely for a sectorwide downturn by giving it a crucial margin of error. Put another way: The market seems to be already pricing in a slowdown in Dow's business. This bodes well for new Dow investors.

It's also worth remembering that Dow is an industry leader and has been through many cycles. The company looks like an excellent value with a high dividend yield that should hold up in a slowdown.