It is understandable that dividend investors often start their search for investment candidates by looking at dividend yield. But just picking the highest-yielding stocks isn't likely to be a winning strategy over the long term. You need to do more digging.
A look at the three highest-yielding stocks in the S&P 500 index, Walgreens Boots Alliance(NASDAQ: WBA), Altria Group(NYSE: MO), and Verizon Communications(NYSE: VZ), helps explain why.
Walgreens is struggling
If there's one thing that no dividend investor wants to see it's likely to be a dividend cut. But that's exactly what Walgreens did at the start of 2024, taking its quarterly payment from $0.48 per share to $0.25. That's a nearly 50% reduction in the payment, something that a company wouldn't do without a very good reason.
In Walgreens' case, the reason is that the company is struggling. Its efforts to expand into drug benefit management didn't pan out. Then it shifted gears and started opening emergency medical clinics, which didn't go as well as planned. The CEO who orchestrated the clinic effort stepped down and the retailer is now working on streamlining its operations under a new CEO. And then there's the dividend cut to add to the company's negative press.
All in, Walgreens' hefty 9.7% dividend yield is an indication that investors believe the company is a high-risk investment. At the very least, it is a high-risk turnaround stock, which is something that only the most aggressive investors should own. Most will be better off avoiding Walgreens stock today.
Altria has many missteps to make up for
Altria is one of the largest cigarette makers in the United States, with control of the largest brand in the market (Marlboro). But there's a small problem. Cigarette volumes have been in a long-term decline. For example, in the second quarter of 2024 cigarette volumes fell a huge 13% year over year! The company isn't ignorant of the problem and offsets the volume decline with price hikes. But it can only do that so many times before consumers will begin to balk.
It has also been trying to invest in new product categories to find a replacement for its declining core operations. That process hasn't gone well, with failed investments in marijuana and vaping (Juul). It also ended up creating a competitor in the non-cigarette space when it spun off Philip Morris International(NYSE: PM) to own its foreign cigarette business. Philip Morris International is now breaking into the U.S. market with its own non-combustible offerings. That's the background behind Altria's huge 7.8% or so dividend yield.
In fairness, the price hikes have allowed Altria to continue to increase its dividend annually. And the company has added NJOY (vapes) to its roster, a move that has worked out much better than the Juul investment. But this is still a consumer staples company with a deeply troubled core business, which is probably not the best risk/reward option for most investors.
Verizon is a good company in a competitive business
Of the three stocks here, Verizon will probably have the most widespread appeal. It has a large 6.4% yield backed by a growing dividend and well-positioned business. Indeed, it is one of a small number of incumbent telecommunications providers in the United States. It would be difficult, if not impossible, to replace the cellphone infrastructure that Verizon has in place. And customers tend to be fairly loyal, leading to annuity-like income streams.
The problem is that keeping up with Verizon's peers is a constant battle that requires heavy capital investments. Falling behind is not a good option, so competition is pretty fierce and costs are always pretty material given the constant improvement in technology. That's where the big risk here comes in, because Verizon's leverage is higher than that of either of its closest peers. That increases risk, though Verizon still remains a better-positioned company than either Altria or Walgreens. For highly conservative dividend investors Verizon is probably a pass, but for most it will likely be worth a deep dive.
Look past the dividend yield
There's nothing wrong with a dividend investor using dividend yield as a first cut to find stocks to look at. But the quick overview of Walgreens, Altria, and Verizon highlights just how important it is to look deeper than dividend yield. When you do that, you'll find that high yields often come with high risks. The question is whether those risks are worth taking. More often than not, the answer will be no.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Philip Morris International and Verizon Communications. The Motley Fool has a disclosure policy.
