Should You Buy the 10 Dow Dividend Stocks That Just Made New All-Time Highs?

The Dow Jones Industrial Average is underperforming the S&P 500 and Nasdaq Composite year to date. But there are 10 dividend-paying Dow components that reached new all-time intraday and closing highs within the last month.

Of the 10, The Home Depot (HD 0.94%) and Microsoft (MSFT 1.82%) stand out as the best dividend stocks to buy now. Here's why.

Image source: Getty Images.

New heights

Investor optimism and growing earnings helped the following 10 Dow components reach new all-time highs in recent weeks.

Data source: Yahoo! Finance. Table by author.

Over half of Dow components are hovering around their 52-week highs, but all-time highs are a different story. For example, Intel is still far from its all-time high, which occurred when the dot-com bubble burst. International Business Machines is around 15% away from its all-time high from March 2013.

Home Depot is a foundational holding

Home Depot has been a secular growth story hiding in plain sight. Its revenue growth has nearly mirrored the increase in the Case-Shiller Home Price Index. The index tracks the value of the U.S. residential real estate market.

Over the last 10 years, the index is up 91.9%, while Home Depot's revenue is up 93.7%. Meanwhile, over the last five years, the index is up 50.9%, and Home Depot's revenue is up 40.2%.

HD Operating Margin (TTM) data by YCharts

Home Depot's top-line growth, paired with margin expansion, has opened the door to stronger earnings and made the company a better value. A 14.5% operating margin for a high-volume retailer is nothing short of incredible.

For context, Lowe's has a 12.8% operating margin, Target is 4.7%, and Costco Wholesale has a mere 3.4% margin. Supporting a high margin requires effective supply chain management, forecasting, inventory management, cost management, and brand power. Home Depot has it all in spades.

Home Depot is an excellent business, but it is also a solid stock. The company's dividend is up more than 53% in the last five years, and it has raised it every year (except in 2008 and 2009) since 1988.

Home Depot also buys back a lot of stock, which has reduced its share count and improved its earnings per share. At just a 23 price-to-earnings (P/E) ratio, Home Depot is a great overall value in an expensive market.

Microsoft isn't overvalued despite its surging stock price

Out of all the Dow dividend stocks making new all-time highs, Microsoft is perhaps the best example of why earnings growth can make what looks to be an overbought stock a fair price.

There's a lot of talk about how artificial intelligence (AI) is going to accelerate growth for many tech companies. Microsoft has that potential as well, but it also has incredibly high-margin, established businesses. In its recent quarter, Productivity and Business Processes had a 53.4% operating margin, its Intelligent Cloud business unit had a 48.2% operating margin, and its hardware-oriented More Personal Computing segment had a 25.4% operating margin.

Microsoft isn't a company whose growth is based entirely on future prospects. It has a roster of established businesses that are doing well right now.

Microsoft's true growth engine is its Intelligent Cloud segment. Developers are building solutions on Microsoft Azure's OpenAI Service. Microsoft made the service available in January 2023. Since then, it has acted as a sandbox for securely building and testing applications. To quote Microsoft's fiscal 2023 annual report:

Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones; datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources; and multi-tenancy locations that lower application maintenance labor costs.

In short, Intelligent Cloud is the segment that includes all of Microsoft's server products and cloud services, from Microsoft Azure to GitHub, as well as enterprise services like Microsoft Consulting. In the first half of fiscal 2024, Intelligent Cloud generated more revenue and operating income than in all of fiscal 2020 -- while also sporting impressive operating margin growth.

Data source: Microsoft.

Even crazier -- Intelligent Cloud in the first half of fiscal 2024 generated nearly the same operating income as all of Microsoft in fiscal 2013.

Microsoft's diluted earnings per share are up 145.8% in the last five years, over 50% in the last three years, and nearly 20% in the last year. Microsoft has a 36.8 P/E ratio, which seems high. But it's not that high if Microsoft can keep growing earnings at 15% to 20% per year.

If a company grows earnings at a compound annual growth rate (CAGR) of 20% per year, its earnings will roughly double in four years and triple in six years. A 15% CAGR will result in earnings doubling in five years and tripling in eight years.

Earnings growth is never that steady. But in general, a company that can sustain growth over time will be a good investment even if the valuation is expensive today.

If Microsoft can grow earnings at a CAGR of 15% per year, its current P/E ratio will start to look very cheap very quickly if the stock price languishes.

I think the investment approach to Microsoft is fairly straightforward. It's a play on AI without the risks that come with investing in a company valued entirely on its future earnings.

I'd also argue Microsoft isn't overvalued right now. If the earnings growth rate starts slipping, it would be a different story. But there's no sign of that now.

Microsoft has a 0.7% dividend yield, which sounds low. But the stock is up over 280% in the last five years, which has compressed the yield.

Microsoft remains committed to the dividend, which has more than doubled over the last eight years. Except for 2010, Microsoft has raised its dividend every year for the last 20 years. Even if Microsoft stock falters, investors can still count on the dividend to keep growing for decades.

Two quality companies you can count on

Home Depot and Microsoft are two completely different businesses. But they both benefit from having strong brands, solid growth, margin expansion, and -- most importantly -- both companies simply execute when the stakes are high.

Good companies have a way of justifying a premium valuation over time. That has applied to Home Depot and Microsoft, and there's no reason to think it shouldn't still apply with both stocks at all-time highs. Investors looking for strong companies they can count on should consider Home Depot and Microsoft over the other eight Dow dividend stocks that just made all-time highs.