The Dow Jones Industrial Average (DJIA) is home to 30 industry-leading companies, many of which pay dividends. Yet even the DJIA hasn't been immune to the market sell-off. In fact, it has joined the S&P 500 and the Nasdaq Composite as the latest major index to fall into a bear market.
Dow Inc. (DOW 1.11%), formerly known as Dow Chemical, is one of the largest chemical companies in the world. The "Dow" in Dow chemical has nothing to do with the "Dow" in the DJIA. But to make matters more confusing, Dow is one of the 30 components in the DJIA.
Dow currently has the lowest price-to-earnings ratio of any component at just 4.9. And it has the second-highest dividend yield (behind Verizon) at 6.3%. Here's why Dow is a dirt cheap high-yield dividend stock worth considering now.
A brief background on Dow
In 2019, a chemicals conglomerate called DowDuPont split into three companies -- DuPont de Nemours (DD 0.10%), Corteva (CTVA -0.50%), and Dow. In general, the difference between the three companies is that DuPont makes specialty chemicals (lower volume, higher margin), Corteva makes agriculture chemicals, seeds, and related specialty chemical products, and Dow makes commodity chemicals (high volume, lower margin). In this vein, Dow can be more cyclical than the other chemical companies since it is more dependent on the price of feedstocks like oil and natural gas, as well as the price it can fetch for its end products.
Dow benefits when oil and natural gas prices are low, and prices for its end products are high. However, oil and natural gas prices are relatively high right now. And there are fears that feedstock prices could stay high while commodity chemical prices fall due to an economic slowdown.
The relationship between rising costs and revenue
A good way to view the impact of higher costs on Dow's business is to look at its cost of goods sold (COGS), revenue, and COGS as a percentage of revenue. COGS includes key items like labor costs, raw material costs, and power consumption for making products. For a manufacturing company like DOW, COGS will be the highest expense. By comparison, a software company with low raw material and labor costs may spend more on research and development, sales, marketing, and advertising than COGS.
In the chart above, we can see that COGS and revenue are both at their highest levels since Dow spun off from the conglomerate, suggesting that it hasn't experienced a slowdown in its business -- yet. Also, notice that COGS as a percentage of revenue is much lower now than it was when revenue was falling and oil and gas prices were low during the peak of the COVID-19 pandemic in 2020. In sum, Dow has offset higher input costs with higher prices for its commodity chemicals.
The chart suggests that higher oil and gas prices aren't necessarily the end of the world for Dow. To bring home the point even further, take a look at Dow's gross profit margin and trailing twelve-month gross profit.
Both are near their highest levels since the spinoff, suggesting that revenue is outpacing COGS and driving profits.
Setting expectations for Dow
As good as Dow's results have been, the concern is that margins will compress, and overall revenue could fall faster than COGS. Even if that happens, Dow is well positioned to remain a cheap stock and support its dividend. The company has a payout ratio of 30.8%, which is healthy and suggests that earnings could be cut in half or even by two-thirds and the company would still able to afford its dividend.
Investors should keep a close eye on Dow's COGS as a percentage of revenue to see how commodity chemical prices hold up if demand falls faster than feedstock prices. However, given the margin of safety for Dow's dividend, not to mention the stock's dirt-cheap valuation, Dow is a reliable blue chip dividend stock to buy now.