There is arguably no global index that garners more attention than the Dow Jones Industrial Average. Comprised of 30 U.S. multinational companies, the Dow's performance has helped provide a tangible signal as to the health of the U.S. economy for nearly 120 years.
One aspect shared by the Dow's 30 components is that all pay a dividend to shareholders. Paying a dividend isn't in itself uncommon for a publicly traded company -- around 40% of all public companies paid a regular or special dividend to investors over the trailing-12-month period -- but considering that not all dividends are created equally, and that these companies are perceived to be among the U.S.' most elite companies, their payouts are closely monitored by Wall Street and investors.
The importance of the dividend payout ratio
One of the easiest methods used to track the health of a company's dividend payment is the dividend payout ratio. A dividend payout ratio takes into account the amount a company is paying in the form of a dividend on an annual basis as a percentage of its profit per share. For example, if a company is paying out $0.50 per quarter and it earns $5 per year in EPS, its dividend payout ratio would be 40% ($0.50 X 4 = $2, and $2 divided by $5 is 40%).
Dividend payout ratios can be especially useful in determining whether a company is in danger of a cut to its payout or if the opposite is true and it's being stingy by not sharing an ample portion of its profits with investors. Although there is no magic formula as to what percentage is ideal for a dividend payout ratio since some industries are more capital intensive than others, I personally like to see mature businesses return in the range of 50% to 75% of their EPS per year to shareholders in the form of a dividend.
Three Dow stocks with the highest dividend payout ratio
With this in mind, today we're going to take a brief look at the three Dow components with the highest dividend payout ratio (based on their adjusted trailing-12-month EPS) to determine if their payouts appear sustainable or if there could be danger on the horizon.
Verizon (NYSE:VZ): 89% dividend payout ratio
Telecom giant Verizon is no stranger to a high dividend payout ratio, but investors have plenty of reasons to believe that Verizon's long-term dividend is sustainable.
To begin with, a strong component of Verizon's wireless and content business involves contracts. These contracts provide some base level of cash flow for the company to base its capital expenditures on. Furthermore, with very few content and wireless options for consumers, providers like Verizon are sitting in the driver's seat when it comes to pricing power. It also doesn't hurt that Verizon's next-generation 4G LTE network is still well ahead of its peers in terms of nationwide coverage. Compound these points with Verizon's retail churn rate (the percentage of wireless customers it lost during the quarter) of just 0.9% in the second quarter, its lowest reading in three years, and you have a handful of reasons why Verizon's 4.7% dividend yield appears to be perfectly healthy and sustainable.
McDonald's (NYSE:MCD): 76% dividend payout ratio
Unlike Verizon, the golden arches have been struggling mightily. The entrance of fresh Mex casual dining restaurants (ahem, Chipotle Mexican Grill) and healthy-portion casual stops (cough, Panera Bread, cough) has made it very difficult for McDonald's to grow its top and bottom lines.
Nonetheless, McDonald's has taken steps to streamline its business. Job cuts at its home office, the sale of restaurants to franchisees, and a restructuring of its international operations are expected to save $300 million annually. In terms of innovation, McDonald's has worked on freshening up its interior to make it more family-friendly, while also reducing the size of its menu. Over the years, McDonald's menu had swelled to well over 100 items. Sometimes, less is more in the retail world, and a more concise menu should help speed up its slow drive-thru response times.
Though McDonald's business model doesn't exactly look as if it's booming, it's not broken, either. For dividend investors, it means future dividend increases may be minimal or put on hold altogether, but it appears unlikely at present that a cut would be in order, with its payout ratio still reasonable in the mid-70% range.
Procter & Gamble (NYSE:PG): 66% dividend payout ratio
Lastly, consumer goods giant Procter & Gamble, the company responsible for Tide detergent, Crest toothpaste, and a bounty of other products in your house (including Bounty!), sports a trailing dividend payout ratio of 66%.
Compared to Verizon, whose business has been performing well, and McDonald's which has been struggling, P&G's operations land somewhere in the middle. Certain aspects have clicked, such as its efforts to spend heavily on promoting its core brands like Tide and jettisoning slow-growing brands. For instance, Procter & Gamble announced the sale of 43 beauty products to Coty for $12.5 billion in July so it could focus on faster-growing market segments.
On the other hand, P&G's sales dipped for the sixth straight quarter in the second quarter, although when accounting for currency fluctuations they actually grew by 1%. The concern here is that if P&G isn't able to find traction in emerging markets and is forced to rely on price hikes in developed markets, its growth could stagnate. The good news is P&G still has levers it can pull with regards to cost-cutting and more asset sales.
All told, with a 59-year streak of dividend increases on the line and a product portfolio chock-full of basic-need inelastic goods like toothpaste and detergent, I don't foresee P&G's dividend declining anytime soon.