3 Dogs Of The Dow To Buy, 1 To Avoid

 |  Includes: DD, INTC, PG, VZ
by: Bidness Etc

Investors love dividend stocks. Here, we take a look at 2012's "Dogs of the Dow" and analyze their attractiveness from a dividend standpoint. We have analyzed their dividend history and cash flows to determine if their payouts are sustainable in the long term. In the end, we will give our recommendations on each stock based on certain key financials.

Intel Corporation (NASDAQ:INTC)

Intel Corporation designs, manufactures, and sells integrated digital technology platforms, primarily in the Asia-Pacific, the Americas, Europe, and Japan. The company offers microprocessors that process system data and controls other devices in the system. It also offers chipsets, which send data between the microprocessor and input, display, and storage devices such as keyboards, mouse, monitors and hard drives. The company primarily markets its products to original equipment manufacturers, original design manufacturers, and industrial and communications equipment manufacturers in the computing and communications industries.

INTC has an attractive dividend yield of 3.2% and a relatively lower payout ratio of 34%. The company's dividends per share have shown impressive growth over the years, rising by 16% in FY2012, compared to the previous year. INTC has high gross margins, largely due to an impressive two year revenue CAGR of 24%. Earnings were volatile for the company between 2005 and 2009, however, it was able to show some growth in FY2011. ROE hit a low of 11% in 2009, but has since rebounded and is currently at almost 27%.

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As the graph shows, the company has a history of increasing its dividend payments. In fact, they have risen by almost 26% over the past decade. INTC has a low payout ratio, and has historically stayed below 50%, which is always a plus as it leaves room for consistent dividend growth, minimizing the impact of short-term fluctuations in earnings. The company also has a free cash flow yield of 5%, which compares well to its dividend yield of 3.2%. Moreover, it has operating cash flows of almost $20 billion and has shown a healthy growth in recent years, indicating its cash generating ability. In 2011, the company paid almost $4 billion in dividends, which was well supported by its operating and free cash flows.

Currently, INTC is trading at 11 times earnings, yields 3.2% and appears to have a sustainable dividend payout based on its free cash flow yield and operating cash flows. Therefore, we believe that INTC is a good dividend stock to hold.

Procter & Gamble (NYSE:PG)

Procter & Gamble, together with its subsidiaries, provides consumer packaged goods and improves the lives of consumers worldwide. The company operates through six segments. PG provides its products in approximately 180 countries through retail operations, including mass merchandisers, grocery stores, membership club stores, drug stores, department stores, salons, and high-frequency stores.

PG has a dividend yield of 3.8%, and its dividends per share have shown steady growth over the years, increasing by 6% in FY2012, compared to the previous year.

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The company's gross margins have historically remained high and flat at 50%, with a modest two year CAGR in revenues of 4%. PG has shown an earnings growth of 11% and 10% over one and five years respectively, moving on a continuous upward trend. ROE is currently 14%, which is low compared to the company's ROE in the early 2000's. Dividend growth over a 5-year period is 11%, which is slightly higher than earnings growth over the same period. However, in the past year, earnings growth surpassed dividend growth. The company has a payout ratio of 64%. In 2011, the company paid around $6 billion in dividends, which was well supported by its operating cash flows of $13 billion and free cash flows of $8 billion. Its free cash flow yield of 4.6% also compares well to the current dividend yield. PG's operating cash flows have been volatile over the years, but not enough to raise any alarms, and are currently at $13 billion (yearly basis).

PG has a P/E of 18x and is trading at a discount to the industry average, indicating it has potential to add value, yields 3.8% and has a payout of 64%, which is very much under control. Moreover, its cash flows can sustain the impressive dividend growth that the company has shown over the past decade. On these grounds, we believe PG has the potential to be an attractive dividend stock.

E. I. du Pont de Nemours and Company (NYSE:DD)

E. I. du Pont de Nemours and Company operates worldwide as a science and technology-based company. Its agriculture segment provides hybrid corn and soybean seeds, and grains under the Pioneer brand name, as well as herbicides, fungicides, and insecticides. The company's electronics & communications segment supplies materials and systems for photovoltaic products, consumer electronics, displays, and advanced printing. Its pharmaceuticals segment represents its interest in the collaboration relating to Cozaar/Hyzaar antihypertensive drugs.

DD has a dividend yield of 3.5%, and its dividends per share have increased by 4% in FY2012, compared to the previous year. However, dividend growth has been stagnant since 2007, as shown in the graph below.

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The company posted gross margins of 24% for FY 2011 and 2010, and 27% for FY2012, and an impressive two year CAGR in revenues of almost 21%. DD has shown an EPS growth of 12% and 2% over a one and five year period respectively, and its earnings are consistently increasing. Moreover, it has consistently beaten consensus analysts' estimates and given positive earnings, with a surprise of 23% in the September quarterly results. Its ROE has stayed in the range of 7% and 39% in the past five years, whereas the number was 33% in FY2011. DD has a current payout ratio of 44%, and in 2011, the company paid an annual dividend of $1.53 billion, which was well backed by its operating cash flows of $5 billion and levered free cash flows of $4 billion. Currently, DD has a free cash flow yield of almost 9%, which is sufficient to cover the company's dividend yield of 3.5%. DD's P/E is at a discount to its industry average, meaning that the stock might currently be undervalued. The company has a strong balance sheet with a reasonable amount of debt, and its liquidity requirements are very much under control.

To sum up, the stock offers an attractive dividend yield, which is justified by its cash flow strength and earnings growth. The payout ratio of 44% is very much manageable, with no signs of dividend cuts in the near future.

Verizon Communications Inc. (NYSE:VZ)

Verizon Communications Inc. provides communications, information, and entertainment products and services to consumers, businesses, and governmental agencies worldwide. It operates in two segments, Verizon Wireless and Wireline. As of June 12, 2012, it served 93 million retail customers in the United States.

The company has high gross margins of almost 60%, which have remained stable over the last five fiscal years. A two-year modest CAGR in revenues of 1.5% is in line with the growth in cost of revenue. VZ has not been able to increase its earnings per share over the past five years, and its earnings have been on a continuous decline since 2007. Without earnings growth, the company's ability to generate dividend growth is also very slim, as evidenced by its dividend history.

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Looking at the company's dividend history, it is clear that VZ is slowing its dividend growth YOY (1.26% in 2011, 2.6% in 2010 and 3% in 2009). VZ's ROE has declined over the years as well, and is currently at 12%. The company has a high dividend yield of 4.60% and a payout of 210%, which is also high, given that EPS growth has been stagnant over the past five years. This could mean that dividend growth may drop to zero going forward, with the possibility of a dividend cut. VZ had free cash flows of $9 billion as of the most recent year end, yielding 7%, which compares well to its dividend yield of 4.60%. Moreover, its operating cash flows have been stable at around $30 billion YOY. In 2011, VZ paid dividends of almost $5.6 billion, which is supported by its free cash flows. Currently, VZ is trading at 47 times earnings and at a premium to the industry average. Other multiples are at a premium to the industry as well. The company has a debt to equity ratio of a little more than 50%, and had an interest expense of almost $3 billion in FY2011.

We believe that with rising debt levels and declining earnings, the company may find it difficult to sustain its current payout ratio for too long. The stock is trading near 52-week highs, and we recommend that investors wait for a better entry point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.