Dividend investors are always seeking new investment opportunities. One old idea for generating investment ideas is known as the Dogs of the Dow. In this approach, you just buy the highest-yielding stocks included in the Dow Jones Industrial Average. For most investors, that approach is too robotic; however, it is definitely worth examining the highest-yielding stocks in the index from time to time.
Today, the top three high-yield stocks in the Dow are Verizon Communications (VZ +0.17%) with a lofty 6.8% yield, Chevron (CVX 4.29%) with an attractive 4.5% yield, and Merck (MRK +1.33%) with a somewhat more pedestrian 3.2% yield. Here's a quick look at each one.
1. Verizon's a wait-and-see
When it comes to dividend investing, the dividend yield is the story with Verizon. Over the past decade, its dividend has grown by only 22%. Cherry-picking a comparison, retailer Costco Wholesale's (COST +1.53%) dividend has grown roughly 225% over the same span. Of course, Verizon's yield is 6.8% while Costco's yield is a tiny 0.6%. If you buy Verizon today, the yield is likely to make up the vast majority of your return if history is any guide.
NYSE: VZ
Key Data Points
That said, there are some key issues to consider before purchasing Verizon. For starters, it operates in a capital-intensive industry and carries a significant amount of debt on its balance sheet. That's unlikely to change anytime soon, so slow growth is probably the norm despite the annuity-like income stream it derives from its telecommunications business. It simply can't stop investing if it wants to maintain its subscriber base.
A potentially bigger concern could be the safety of the dividend. That's not necessarily because it can't support the dividend it is paying, but because the company recently brought in a new CEO tasked with boosting the company's growth. It wouldn't be surprising to see a new CEO ask the board of directors to reset the dividend to free up cash for other purposes.
Conservative dividend investors may want to take a wait-and-see approach here, giving the new boss more time at the helm.
Image source: Getty Images.
2. Chevron is always attractive in the energy sector
Chevron operates in the highly volatile energy sector, yet it maintains an impressive dividend track record nonetheless. With 38 years of consecutive annual dividend increases, Chevron is one of the most reliable dividend stocks in the sector. If you are looking for energy exposure, it is almost always a solid choice.
There are two main reasons. First, the company is diversified across the entire energy sector, with exposure to energy production, energy transportation (pipelines), and chemicals and refining. This helps to mitigate the swings caused by volatile oil and natural gas prices, as each segment of the industry operates slightly differently throughout the energy cycle.
Second, the company has a rock-solid balance sheet, with a debt-to-equity ratio of just 0.22 today. That allows Chevron to add leverage during industry downturns so it can support its business and dividend until energy prices recover, as they always have historically.
NYSE: CVX
Key Data Points
Energy is vital to the world, and most investors should have some exposure to the sector. Chevron is an attractive way to get that exposure, and today's lofty 4.5% yield is pretty enticing.
3. Merck will get through what ails it
Last up is pharmaceutical giant Merck. The 3.2% yield isn't particularly huge, and you can easily find higher-yielding stocks in the drug niche. However, most of those stocks will also come along with a higher dividend payout ratio. Merck's payout ratio is a very reasonable 45% or so. That's an important distinction right now.
Like many of its peers, Merck is dealing with patent expirations. New drugs are granted temporary patent protections, which allow a drugmaker to make robust profits for a short period of time. The intent is to help the drug company offset the high costs associated with finding and developing new drugs. However, when a patent expires, profits can fall dramatically as generic competition arrives, a phenomenon known as a patent cliff.
NYSE: MRK
Key Data Points
With a patent cliff on the horizon, investors are worried that Merck won't develop new drugs before it goes over the edge of that cliff. However, unlike some higher-yielding peers, Merck's reasonable payout ratio provides it with considerable leeway on the dividend front before a dividend cut would likely be considered.
If you are looking for a drug stock, Merck is probably a good balance between dividend risk and dividend reward. Indeed, it has managed to thrive in the competitive sector despite facing this same dynamic many times before.
Two to consider and one to watch
When you step back and look at the top three high-yield stocks in the Dow, Chevron and Merck look like they are probably worth buying today. Verizon, however, isn't quite as clear-cut, since a lot will depend on what the new CEO chooses to do. You should probably watch Verizon for a while to see what happens during the leadership transition before considering buying it.
