10 Dow Dividend Stocks Fail 'Acid Test'

NEW YORK (TheStreet) -- When the Federal Open Market Committee reaffirmed its target interest rate of 0% to 0.25%, it sent the yield on the 10-year Treasury note down to a meager 2.55%. As a result, the dividend yields on large-cap stocks have become a tempting alternative to fixed-income securities, but investors should not blindly assume the risks of equities for enhanced yield.

In the past, we have suggested that income investors periodically subject their portfolio to a "Dividend Acid Test*" -- a pass/fail exam that indicates if a company's dividend payout is covered, in full, by the company's liability adjusted cash flow yield (LACFY**).


Of course, a failing grade does not ensure that a dividend cut or elimination is imminent, but rather, that the failed company may have difficulty continuing payouts in the face of operational adversity or a large debt maturity. Similarly, a passing grade offers no guarantee that a company will not face a prolonged hardship or that the company's management will sustain its current dividend policy. Investors must always be cautious.

Of the 30 stocks that comprise the Dow Jones Industrial Average, 29 issues currently offer a dividend ( Cisco ( CSCO), the one absent issue, plans to offer a dividend in July 2011), and 18 issues pass our most stringent acid test (using 10-year average cash flow data).

However, a truly cautious investor also may wish to consider one additional criterion: The effective tax rate paid by each respective company.

As Benjamin Graham states in The Intelligent Investor, "Certain companies which have had large losses in the past have been able to report future earnings without charging the normal taxes against them, in that way making a very fine profits appearance indeed -- based paradoxically enough on their past disgraces."

Additionally, government tax subsidies may further distort the future earnings power of a corporation.

Considering the above facts, it should not comes as a surprise that the relative tax rate of Dow components differed by as much as 1,100%, averaged over the last five years. Investors seeking to preserve principal would be wise to consider the entire financial picture of a company before committing capital.

As a starting point for your research, the following pages contain pass/fail results for 28 of the 30 companies that comprise the Dow Jones Industrial Average -- ranked in ascending order by liability adjusted cash flow yield.

*Pass = Dividend yield less than LACFY, Fail = Dividend yield greater than LACFY

**LACFY is defined as: 10-Year Average Free Cash Flow / (((Outstanding Shares + Options + Warrants) x (Per Share Price) + (Liabilities)) - (Current Assets - Inventory))

Note: Insurance companies cannot be valued using a simple cash flow formula -- as a result -- Travelers has been omitted from this list. The five-year tax rates used in this story reference Morningstar tax data from 2005-09.

28. Alcoa ( AA)

Alcoa is engaged in the production and management of primary aluminum, fabricated aluminum and alumina. (more >>)

  • Liability Adjusted Cash Flow Yield: 0.7%
  • Dividend Yield: 1.07%
  • Coverage Ratio: 0.65
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 28.4%

27. Caterpillar ( CAT)

Caterpillar provides construction and mining equipment; diesel and natural gas engines and industrial gas turbines. (more >>)

  • Liability Adjusted Cash Flow Yield: 1.9%
  • Dividend Yield: 2.3%
  • Coverage Ratio: 0.83
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 25%

26. Wal-Mart ( WMT)

Wal-Mart operates Wal-Mart discount stores, supercenters, Neighborhood Markets and Sam's Club locations in the U.S. (more >>)

  • Liability Adjusted Cash Flow Yield: 2%
  • Dividend Yield: 2.26%
  • Coverage Ratio: 0.88
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 33.5%

Note: Wal-Mart passes when using five-year average cash flow data, see here >>

25. JPMorgan Chase ( JPM)

JPMorgan Chase is a global financial services firm with banking institutions in the U.S. and operations worldwide. (more >>)

  • Liability Adjusted Cash Flow Yield: 2.3%
  • Dividend Yield: 0.49%
  • Coverage Ratio: 4.69
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 28.3%

24. Bank of America ( BAC)

Bank of America is a bank holding and a financial holding company, which through its subsidiaries, provides banking and nonbanking financial services and products throughout the U.S. and in select international markets. (more >>)

  • Liability Adjusted Cash Flow Yield: 2.4%
  • Dividend Yield: 0.29%
  • Coverage Ratio: 8.28
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 27%

23. McDonald's ( MCD)

McDonald's franchises and operates McDonald's restaurants in the food service industry. The company and its franchisees purchase food, packaging, equipment and other goods from numerous independent suppliers. (more >>)

  • Liability Adjusted Cash Flow Yield: 2.5%
  • Dividend Yield: 2.91%
  • Coverage Ratio: 0.86
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 30.7%

Note: McDonald's passes when using five-year average cash flow data, see here >>

22. Kraft ( KFT)

Kraft, through its subsidiaries, manufactures and markets packaged food products, including snacks, beverages, cheese, convenient meals and various packaged grocery products. (more >>)

  • Liability Adjusted Cash Flow Yield: 2.7%
  • Dividend Yield: 3.67%
  • Coverage Ratio: 0.74
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 28.2%

21. AT&T ( T)

AT&T is a holding company whose subsidiaries and affiliates provides wireless and wireline telecommunications services and equipment as well as directory advertising and publishing services in the U.S. and internationally. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.1%
  • Dividend Yield: 5.87%
  • Coverage Ratio: 0.53
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 32.4%

20. Verizon ( VZ)

Verizon Communications provides communications services through two reportable segments, Domestic Wireless and Wireline. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.2%
  • Dividend Yield: 6.03%
  • Coverage Ratio: 0.53
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 25.8%

19. Chevron ( CVX)

Chevron provides administrative, financial, management and technology support to U.S. and international subsidiaries that engage in operations of petroleum, chemicals, mining, power generation and energy services. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.3%
  • Dividend Yield: 3.61%
  • Coverage Ratio: 0.91
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 44%

18. Coca-Cola ( KO)

Coca-Cola is a manufacturer, distributor and marketer of nonalcoholic beverage concentrates and syrups in the world. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.5%
  • Dividend Yield: 3.03%
  • Coverage Ratio: 1.16
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 23.6%

17. DuPont ( DD)

E.I. du Pont de Nemours operates globally and offers a range of products and services for markets including agriculture and food, building and construction, electronics and communications, general industrial, and transportation. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.5%
  • Dividend Yield: 3.66%
  • Coverage Ratio: 0.96
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 21.2%

16. Procter & Gamble ( PG)

Procter & Gamble is focused on providing branded consumer packaged goods -- the company markets its products in more than 180 countries. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.6%
  • Dividend Yield: 3.13%
  • Coverage Ratio: 1.15
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 27.5%

15. Disney ( DIS)

Disney is an entertainment company with operations in four business segments: Media Networks, Parks and Resorts, Studio Entertainment and Consumer Products. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.7%
  • Dividend Yield: 1.01%
  • Coverage Ratio: 3.66
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 35.4%

14. Merck ( MRK)

Merck is a global pharmaceutical company that discovers, develops, manufactures and markets a range of products to improve human and animal health. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.8%
  • Dividend Yield: 4.14%
  • Coverage Ratio: 0.92
  • Dividend Acid Test: FAIL
  • 5-Year Tax Rate: 21.1%

13. United Technologies ( UTX)

United Technologies provides technology products and services to the building systems and aerospace industries worldwide. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.9%
  • Dividend Yield: 2.41%
  • Coverage Ratio: 1.62
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 27.5%

12. Home Depot ( HD)

Home Depot is a home improvement retailer. The company's stores sell an assortment of building materials, home improvement and lawn and garden products and provide a number of services. (more >>)

  • Liability Adjusted Cash Flow Yield: 3.9%
  • Dividend Yield: 3.06%
  • Coverage Ratio: 1.27
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 36.7%

11. Boeing ( BA)

Boeing operates as an aerospace firm. The company is engaged in the design, development, manufacture, sale and support of commercial jetliners, military aircraft, satellites, missile defense and human space flight services. (more >>)

  • Liability Adjusted Cash Flow Yield: 4.3%
  • Dividend Yield: 2.62%
  • Coverage Ratio: 1.64
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 28.2%

10. American Express ( AXP)

American Express is a global payments, network and travel company, which offers credit payment card products and travel-related services to consumers and businesses around the world. (more >>)

  • Liability Adjusted Cash Flow Yield: 4.4%
  • Dividend Yield: 1.68%
  • Coverage Ratio: 2.62
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 4.1%

9. 3M ( MMM)

3M Company is a global manufacturer, technology innovator and marketer of a variety of products. (more >>)

  • Liability Adjusted Cash Flow Yield: 4.4%
  • Dividend Yield: 2.43%
  • Coverage Ratio: 1.81
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 31.5%

8. ExxonMobil ( XOM)

ExxonMobil is engaged in the exploration, production, transportation and sale of crude oil and natural gas and the manufacture, transportation and sale of petroleum products. (more >>)

  • Liability Adjusted Cash Flow Yield: 5.3%
  • Dividend Yield: 2.86%
  • Coverage Ratio: 1.85
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 42.2%

7. IBM ( IBM)

International Business Machines is a globally integrated enterprise, which creates business value for clients and solves business problems through integrated solutions that leverage information technology and deep knowledge of business processes. (more >>)

  • Liability Adjusted Cash Flow Yield: 5.3%
  • Dividend Yield: 1.97%
  • Coverage Ratio: 2.69
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 28.4%

6. Hewlett-Packard ( HPQ)

Hewlett-Packard is a global provider of products, technologies, software, solutions and services to individual consumers, small and medium-sized businesses and large enterprises, including customers in the government, health and education sectors. (more >>)

  • Liability Adjusted Cash Flow Yield: 5.3%
  • Dividend Yield: 0.8%
  • Coverage Ratio: 6.63
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 19.9%

5. Pfizer ( PFE)

Pfizer is a research-based global pharmaceutical company which discovers, develops, manufactures and markets prescription medicines for humans and animals. (more >>)

  • Liability Adjusted Cash Flow Yield: 5.4%
  • Dividend Yield: 4.2%
  • Coverage Ratio: 1.29
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 18.9%

4. Johnson & Johnson ( JNJ)

Johnson & Johnson is a holding company engaged in the research and development, manufacture and sale of a range of products in the health care field. (more >>)

  • Liability Adjusted Cash Flow Yield: 5.6%
  • Dividend Yield: 3.49%
  • Coverage Ratio: 1.6
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 22.8%

3. General Electric ( GE)

General Electric provides services ranging from aircraft engines, power generation, water processing and household appliances to medical imaging, business and consumer financing, media content and industrial products. (more >>)

  • Liability Adjusted Cash Flow Yield: 5.8%
  • Dividend Yield: 2.91%
  • Coverage Ratio: 1.99
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 11.5%

2. Intel ( INTC)

Intel is a semiconductor chip maker, which develops advanced integrated digital technology products, mainly integrated circuits, for industries such as computing and communications. (more >>)

  • Liability Adjusted Cash Flow Yield: 7.1%
  • Dividend Yield: 3.29%
  • Coverage Ratio: 2.16
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 28.1%

1. Microsoft ( MSFT)

Microsoft generates revenue by developing, manufacturing, licensing, and supporting a wide range of software products and services for many different types of computing devices. (more >>)

  • Liability Adjusted Cash Flow Yield: 7.6%
  • Dividend Yield: 2.07%
  • Coverage Ratio: 3.67
  • Dividend Acid Test: PASS
  • 5-Year Tax Rate: 27.4%

-- Written by John DeFeo in New York City

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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