Should You Buy the 3 Highest-Paying Dividend Stocks in the Dow Jones? | The Motley Fool (2024)

Investing in high-dividend stocks is a time-tested strategy for generating income and potential capital appreciation. One popular approach within this realm is the "Dogs of the Dow" strategy.

This method focuses on selecting the highest-yielding dividend stocks in the Dow Jones Industrial Average (^DJI 0.72%), aiming to capitalize on their potential undervaluation and strong income streams. In this article, we'll explore whether it's a good idea to buy the three highest-paying dividend stocks in the Dow today.

Introduction to the Dogs of the Dow strategy

The Dogs of the Dow strategy involves picking the top 10 highest-yielding dividend stocks from the Dow Jones Industrial Average at the start of each year and holding them for 12 months. This strategy is based on the principle that these high-yield stocks are often undervalued, and as their prices revert to the mean, investors can benefit from both dividend income and capital gains. Historically, this approach has delivered solid returns, making it a popular choice for income-focused investors.

Grabbing the three highest-yielding Dow stocks instead of 10 is a slight variation on the theme. In this case, you're focusing on the most extreme cases of yield-boosting price swoons. If all goes well, these blue chip stocks with an extra large dose of market risk should be set up for fantastic long-term returns. On the flip side of the same coin, turnaround stories often fail, and these high-yielding stocks are legitimately risky.

Current highest-paying dividend stocks in the Dow

As of today, the three highest-paying dividend stocks in the Dow Jones are:

• Telecom powerhouse Verizon Communications (VZ 1.30%)with a dividend yield of 6.7%
• Materials science veteran Dow Inc. (DOW -0.22%)showing a 5.1% yield
• Energy giant Chevron (CVX 1.01%)sporting a dividend yield of 4.2%

Let's take a closer look at each of these companies and their dividend prospects.

1. Verizon

Verizon has always been an income investor favorite. Through thick and thin, the yield has hovered around the 5% line since the mid-1980s. But it has rarely ventured above 6%, and the massive yield you see today may indicate serious issues.

The explosive revenue growth of the early smartphone years has turned into a stagnant trend, vastly overshadowed by T-Mobile US. Verizon's stock has earned its low price and high yield the hard way, and I'm not convinced that the company can climb out of this Wall Street pothole.

2. Dow Inc.

I'll admit that plastics and industrial chemicals aren't exactly my wheelhouse, but judging by Dow's recent business results, maybe that's for the best. The company's sales and free cash flows have been sliding down over the last two years, and not by a little. In April's first-quarter earnings call, management celebrated stable pricing and a 1% increase in shipped product volume. Yet, revenues fell 9% year over year, and free cash flows were negative.

There is a cost-cutting recovery plan in play, but you shouldn't expect rosy results any time soon. The target date for this turnaround is the year 2030. If Dow's turnaround plan makes sense to you and you have the patience to watch it play out over the next six years, you might want to own this high-yielding stock. Otherwise, I'd rather pass on this stock, too.

3. Chevron

And then there's Chevron, another stalwart in a famously high-yielding industry. Like Dow, the company has seen lower sales and cash profits in recent years. A stalled takeover of smaller rival Hessis weighing on Chevron's stock, and the global shift from internal combustion to electric vehicles isn't helping this oil titan, either.

However, Chevron has invested in alternative energy businessesand committed to installing electric vehicle chargers at every Chevron gas station. If you can't beat 'em, why not join 'em? And the company sure has enough cash reserves to pursue a strategy for largely renewable energy systems. If there's a long-term winner in this trio, I'd bet on Chevron today.

Pros and cons of this strategy

Pros:

• Income generation: High-dividend stocks provide a steady income stream, which can be particularly appealing in low-interest rate market environments.
• Potential undervaluation: The strategy targets Dow stocks that might be undervalued, offering opportunities for price appreciation as they get back on their feet.
• Simplicity: The strategy is straightforward and easy to implement. If you intend to follow the Dogs of the Dow recipe to the letter, it requires an annual rebalancing, but the rules are simple, and it only takes a minute.

Cons:

• Dividend cuts: High yields can sometimes signal financial distress, increasing the risk of dividend cuts. You see, super-high dividend yields can sometimes be a sign of serious business problems.
• Concentration risk: Investing in a small number of stocks can lead to higher volatility and risk, even if the focused selection comes from a group of high-quality companies.
• Market conditions: The strategy may underperform in bull markets where exciting growth stocks tend to outshine robust dividend payers.

Performance comparison

Historically, the Dogs of the Dow strategy has performed relatively well compared to the broader market. However, a meta-analysis of Dogs of the Dow studies shows that this strategy tends to underperform an even simpler approach: buying and holding an S&P 500 tracker, like Vanguard S&P 500 ETF (VOO 0.53%), with dividend reinvestments activated.

For example, data from the Dogs-trackers Invesco Dow Jones Industrial Average Dividend ETFand Hennessy Total Return Investorsupport this conclusion over the periods of 1, 3, 5, 8, and 11 years.

The Invesco ETF tracks the whole Dow Jones Industrial Average, weighted by dividend yield. The Hennessy fund looks at the 10 highest-yielding Dow stocks mixed with some ultra-stable Treasuries. Neither is a perfect match for the top three Dow dividends idea, but they do have years of real-world market results. Unfortunately, they have underperformed a simple market tracker in nearly every multiyear time frame.

^SPX data by YCharts.

Conclusion: Is it worth it?

The Dogs of the Dow strategy can offer high income, but it's important to weigh the risks. Verizon faces stagnation and competition, Dow Inc. is in a long-term turnaround, and Chevron is navigating the transition to renewable energy. While their high yields may be attractive, these challenges add significant risk.

Thorough research and a clear understanding of your investment goals are essential before making that decision. If you're comfortable with the risks and focused on income, the highest-paying dividend stocks in the Dow could be worth considering. For many investors, the stability and diversification of an S&P 500 ETF like Vanguard's VOO might be a more reasonable choice.