Should You Buy the 3 Highest-Paying Dividend Stocks in the Dow Jones?

Key Points

• Be careful with stocks that have steep dividend yields.

• Some are tied to struggling companies whose share prices have fallen.

• But these high yielders from the Dow look quite promising.

I've written this kind of article before, addressing whether it's smart to buy into the dividend-paying stocks in the S&P 500 or Nasdaq Composite that have the highest dividend yields. There are some important things to know and to consider, and they're true when you're looking at stocks in the Dow Jones Industrial Average too.

My advice has often been to avoid many such stocks, but in this case, with the Dow, I'm less wary. Read on for how you might think about high-yielders in general, and why you might consider these particular stocks.

Image source: Getty Images.

Dividend basics

Let's start with how dividends and dividend yields work. A dividend is a payment from a company to its shareholders, generally delivered quarterly as a bit of cash that appears in your brokerage account.

Companies that pay dividends have typically grown to the point where they have fairly dependable income and not enough uses for all their income -- so they're able to commit to a dividend program. Once a company starts paying a dividend, it won't want to shrink or eliminate it, as that will displease shareholders and worry would-be investors. (Still, when a company is facing serious challenges, dividends can be reined in for a short or long while.)

To arrive at a company's dividend yield, you take its stock's annual dividend amount (often by multiplying its current quarterly payout by four) and divide that by the stock's current price. So if Home Surgery Kits, Inc. (ticker: OUCHH) is trading at $100 per share and pays out $1 per quarter, you would multiply $1 by four, arriving at an annual dividend of $4, and then divide that by $100, getting 0.04, or 4%. Home Surgery Kits' dividend yield would be 4%.

Why am I going through this math -- especially when you'll often find dividend yields already calculated for you at many stock sites? Well, because it can help you view steep dividend yields more clearly.

With Home Surgery Kits, you can view its dividend yield as 4% and also as a fraction -- 4 divided by 100, or 4/100. The annual dividend is on top and the stock price below. Dividend amounts usually don't change very often, but a stock's price generally changes throughout the trading day and from day to day. When the stock price falls, the yield will therefore rise and vice versa. For example, if Home Surgery Kits' shares fall to $80, the yield would be $4 divided by $80, or 4/80, or 0.05, or 5%. (Note that with the 4% or 5% yield, you're getting the same $4 per year. The yield simply compares that payout to the stock price.)

So a high dividend yield may simply reflect a company with way more cash than it can use, but it very often reflects a struggling company -- one whose stock price has fallen, pushing up the dividend yield.

The highest-paying dividend stocks in the Dow

The Nasdaq stock market and the Nasdaq Composite index encompass more than 3,000 stocks, and the S&P 500 index includes about 500. So when you're looking at the highest-yielding stocks in those groups, you're likely to encounter some companies in trouble, with some steep yields.

That's less likely (but not impossible) when you look at the Dow Jones Industrial Average, though, because it features only 30 companies. When I checked to see which were the three highest-yielding ones currently, I got these:

1. Verizon Communications, recent dividend yield: 6.3%

Verizon Communications (NYSE: VZ) is a giant in the broadband and wireless realm, recently sporting a market value around $184 billion. Its dividend payout has been growing but not at a rapid clip, which can be excused since the yield is so high. The company is carrying a lot of debt, but it's also a cash cow, producing billions of dollars of free cash flow annually, much of which can be devoted to paying down debt -- and paying dividends. The company is also continuing to expand its fiber and 5G networks.

Verizon's shares are also attractively valued at recent levels, with a forward-looking price-to-earnings (P/E) ratio of 9.3 -- which is near the five-year average of 9.1.

2. Chevron, recent dividend yield: 4.61%

Chevron (NYSE: CVX) is one of the biggest integrated oil and gas enterprises, recently valued near $256 billion. It's another cash cow with a strong balance sheet, and it has hiked its payout for 38 years in a row. The recent total annual payout of $6.68 is up from $5.31 in 2021 and $4.48 in 2018.

This is a great long-term income generator if you're bullish on the energy sector. Chevron's forward P/E was recently 17, a bit above its five-year average of 14, suggesting that it's reasonably valued to somewhat overvalued.

3. Merck, recent dividend yield: 3.87%

Then there's pharmaceutical giant Merck (NYSE: MRK), with a recent market value topping $200 billion. Its recent total annual dividend payout of $3.20 is up from $1.99 in 2018.

Merck is quite diversified, with treatments for cancer, diabetes, and more, as well as animal health products. It's also a major vaccine producer. Bears worry about patent protection expirations for some of its products, such as cancer drug Keytruda, but Merck has lots of new products in its pipeline and it's pursuing strategies to extend its patent protections.

Merck's forward P/E was recently 9.2, below its five-year average of 12.4, suggesting that it's attractively overvalued.

So go ahead and consider any of these stocks for your long-term portfolio, as each has a lot of potential.

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Selena Maranjian has positions in Verizon Communications. The Motley Fool has positions in and recommends Chevron and Merck. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.