The Dow Jones Industrial Average (^DJI +1.24%) is fertile ground for income investors. All 30 of its components today offer a dividend, with an average yield around 2.7%. Compare this to the broader S&P 500 index, where a still-impressive 424 out of 500 components offer dividends, but with an average yield of just 1.9%.
It should come as no surprise that The Motley Fool's income-oriented service often goes to the Dow for dividend-paying investments of high quality. The newsletter currently owns no fewer than seven Dow stocks. Among these seven picks, the average yield is 3%. Every single one sits at or above the Dow average. But our top income stock analysts have not selected any of the four richest yields available on the Dow today.
Why would a well-informed income investor go with Johnson & Johnson's (JNJ 0.41%) downright average 2.7% yield, while leaving top Dow yielder AT&T's (T 1.27%) 5.2% yield untouched? That's nearly twice Johnson & Johnson's dividend payout!
For the impatient reader, it boils down to one simple fact: Income investing is not all about backing up the truck to the highest yields. You also must consider factors such as the opportunity for share price gains, the stability of the company's financial foundation, and the quality of management. These items still amount to a superficial analysis, but they're at least a good start.
And AT&T is eating J&J's dust in many ways.
For example, Wall Street analysts expect AT&T to grow its earnings by 5.6% annually over the next five years. For Johnson & Johnson, they expect a 7% annual growth pace.
That doesn't seem like a big difference, but those five years of modest growth should cumulatively add up to something like a 31% earnings increase for AT&T. For J&J, the half-decade growth should land near 40%.
On top of this gap, I actually believe Wall Street is overestimating Ma Bell's growth opportunities. And I'm not just talking about the fact that AT&T's earnings have only increased by 3.2% a year over the last five years, though it takes a leap of faith to assume higher growth in the future.
No, I'm thinking about the structural overhaul that AT&T's biggest market is experiencing.
The wireless sector is going through a massive sea change right now, in which seemingly every company is either buying somebody or getting bought. AT&T is reaching for international growth by spending more than $70 billion to acquire satellite TV provider DIRECTV (DTV +0.00%). It's a bit of a desperate move, designed to boost revenue and cash flow without really changing AT&T's core business. But that's not going to be good enough.
It's true that Johnson & Johnson is part of another consolidating industry, and that analysts expect another magical leap from 4% annual growth to 7% in coming years. However, AT&T is staring down the end of the smartphone boom and wondering what's next. Medical giants are looking at the far more palatable catalyst of retiring baby boomers.
Image source: Johnson & Johnson.
As this generation cashes in its Medicare and Medicaid chips, along with the benefits of widely available Obamacare health-insurance coverage, the accelerated growth projection actually makes sense for Johnson & Johnson. So if you're picking one of these two stocks based on medium-term growth prospects, Johnson & Johnson would be it.
OK, so how about the fundamental platform? AT&T comes with a solid 14% net income margin, $130 billion of annual revenue, and $3.8 billion in cash reserves.
J&J's net margin is an even richer 21%. The company's $72 billion in annual sales may be smaller, but its $29.4 billion in cash equivalents leaves AT&T green with envy.
You should also consider that J&J has more cash than debt, while AT&T balances its nearly $4 billion cash assets against a crushing $80 billion debt load -- and the DIRECTV deal, if successful, will add even more debt.
If I had to pick one of these financial houses as shelter in a storm, I'd prefer J&J's brick walls over AT&T's house of cards. And the storm clouds are already on the horizon.
All right, all right. AT&T lost the first two rounds. Will the telecom's management quality save the day?
I'm afraid not.
For the number crunchers out there, J&J beats AT&T's margins any way you slice it. The company also has a large advantage in efficiency metrics such as return on assets, and a smaller edge when it comes to returns on equity. That means Johnson & Johnson's leadership has a more efficient method for squeezing profits out of its corporate assets, though it's nearly a dead heat in terms of leveraging investor equity.
It doesn't help that AT&T's executive team has its hands tied by an excessive debt load, leaving less wiggle room for exploring new and perhaps costly business ideas. This debt-heavy capital structure is also less than ideal for growing dividends in the future. Hold that thought.
One leader rarely makes an entire company, but the CEO often gets decked out with both the roses and the thorns of every business decision. So let's compare the top executives of these two Dow companies.
Johnson & Johnson handed Alex Gorsky the keys to the CEO suite in 2012, after a 24-year career mostly spent at the company. So he's a longtime insider, having risen from the lowly rank of sales executive to the CEO chair.
Some of Gorsky's business ideas may not be overwhelmingly popular, and he may have made some questionable decisions before taking the CEO job, but I have yet to see him make a total mess of anything at J&J.
That's more than I can say for Randall Stephenson, Gorsky's counterpart at AT&T.
Stephenson is a lifer with his company. He stepped up to the CEO position from the chief operating officer role, just weeks after Apple (AAPL +1.18%) launched the original iPhone with AT&T as its exclusive network partner.
You might think that AT&T would have crushed the market in the smartphone era. Stephenson is, after all, leading one of the two largest networks in America and enjoyed that exclusive iPhone deal for a couple of years. Good things should have happened for shareholders under these favorable circumstances.
But they didn't. AT&T has almost always trailed behind the Dow's returns in the Stephenson era -- even if you include the effects of AT&T's rich dividends:
T Total Return Price data by YCharts.
In 2011, he flunked one major acquisition and was forced to part with $4 billion in cash plus some valuable wireless spectrum as a result. Now he's chasing another megadeal in DIRECTV, and has made a habit of saying some downright ridiculous things to make this blockbuster merger happen.
If Gorsky's finest quality is a lack of major blunders, Stephenson sort of specializes in the art of strategy fumbles.
So again, Johnson & Johnson beats AT&T hands down. Three to nothing, and we're all out of rounds.
I can't speak for the Fool's dividend-focused newsletter analysts, and their exact reasons for picking Johnson & Johnson over AT&T may be somewhat different. But it's not hard to arrive at the same conclusion with my simple three-part analysis tools.
Growth prospects, sound financial figures, and higher-quality management trumps a fantastic dividend yield. Without these essential business qualities, you simply cannot expect those juicy AT&T yields to last as long as J&J's.
