Everyone loves a dividend. And why wouldn't they? Dividends are awesome.
You wake up every day, go to work, or maybe just sit on the couch. You come home, eat dinner, watch TV, and go to sleep. Rinse. Repeat. All the while your investment is paying you money. Why? Because you bought some shares. That's it. No work, just more cash. It's a beautiful thing.
Blue-chip dividends for yield and peace of mind
Buying a dividend stock is not without risk, though. Dividends are only paid when the company can afford to spin off that cash, and oftentimes are only paid when the company can't reinvest that cash into the business and achieve an above-market return.
That's why the best dividend stocks are often large entities with lots of history and tons of staying power. General Electric (NYSE:GE) is a great example. The company is massive (market cap of $257 billion), it has been around forever (formed in 1892), and it generates ridiculous cash flow (nearly $29 billion last year). GE's 3.4% dividend yield isn't the largest you will see in your investing research, but it's better than most and perhaps more importantly, it's rock solid.
But when it comes to the Dow Jones Industrial Average (DJINDICES:^DJI), General Electric can't claim the title of top dividend stock. The blue-chip index's dividend kings are AT&T (NYSE:T) and Verizon (NYSE:VZ).
Breaking it down: AT&T
AT&T boasts the largest dividend yield of any company in the Dow Industrials: 5.2%.
What's driving this dividend and why will it continue? From a financial standpoint, AT&T has very stable revenue, stable net income, and excellent cash flow from operations.
Looking to the future, AT&T is a leading and established telecom player in the U.S. The company has weight and scale in highly capital intensive businesses -- from its cell phone and wireless service businesses to it's U-verse high speed Internet and wired cable products -- to stay relevant and profitable for a long time.
The chart below tells the story. Pay close attention to the cash from operations line -- remember, it takes cash to pay a dividend, not just profit.
Breaking it down: Verizon
Similar to AT&T, Verizon's financial profile is marked by stability, slow and steady growth, and loads of cash flow.
With a 4.4% yield, Verizon is the Dow's No. 2 dividend provider. Verizon's payout is the result of its very successful and highly capital intensive telecom business. Potential competitors are faced with extremely high costs and regulatory burdens to enter the market, and if those rivals are somehow able to gain any footing, Verizon's scale is virtually indomitable.
Once again, the chart tells the story.
The advantage of a blue-chip dividend
Investors can easily find stocks with higher dividend yields than both AT&T and Verizon. There are specialized companies in oil and gas, shipping, real estate, finance, and many other industries that pay out yields of 10 or even 15%! But with those higher yields come a different risk profile -- both risk of loss and opportunity cost.
Many of these entities are designed for the dividend and nothing else. The company won't reinvest its cash flow -- it's a plain and simple method to pay out all cash to shareholders.
The problem is that these companies aren't building a capital base to buffer for future problems. If the company hits a speed bump, the dividend may be cut severely or even eliminated altogether. And when that happens, the share price is sure to follow. It's a double whammy.
Furthermore, without reinvestment into the company any growth must be funded externally -- that means either taking on a ton of debt or diluting shareholders with new equity financing. So if the company does really well, you're still only getting the dividend. The stock price just doesn't have significant upside.
Blue-chip stocks such as AT&T and Verizon don't operate like this. These companies are huge, stable, and protected by highly capital-intensive barriers to entry. They reinvest into the business to fund growth and maintain a strong capital base. The result is a stable and increasing dividend for the long term without sacrificing the potential to grow the company's enterprise value.
When you buy high-quality companies for the long term, you too can enjoy these benefits. AT&T and Verizon are spinning off billions of dollars in cash. An investment in either of these stocks buys you a share of that cash. It's as simple as that.