You may have heard words like “safe” or “reliable” used to describe low-growth, stodgy dividend stocks. And while many boring businesses are also safe dividend stocks, the main differences between a safe dividend stock and a normal dividend stock comes down to the company’s financial health, the type of business it is in, and its brand.

The Dow Jones Industrial Average is chock-full of industry-leading companies that provide a pulse on the overall economy. All but three of the 30 components pay a dividend, making the Dow a good place to look for prospective investments. However, you may notice that the majority of the Dow companies don’t operate in the traditional “safe” sectors of the economy.

But there are safe dividend stocks in cyclical industries that generate plenty of cash to cover their dividends even during a downturn in the business cycle. Caterpillar (CAT) and Home Depot (HD) are two examples of cyclical stocks that may not fit the traditional safe stock mold. Caterpillar has paid and raised its dividend for 29 consecutive years, while Home Depot’s dividend has doubled in the last five years and has never been cut in the company’s history.

Meanwhile, Johnson & Johnson (JNJ) is a Dividend King that has paid and raised its dividend for 60 consecutive years. Given its track record and industry, it’s more of the traditional safe dividend stock. However, the stock is around a 52-week low, which has pushed its dividend yield up to 3%.

Here’s why you can count on all three Dow dividend stocks, and why each is a great buy now.

1. Caterpillar: An investment in global economic growth
This May, Caterpillar will celebrate its 32nd year in the Dow index. The company is well known for its earth-moving equipment. But the company has a massive energy and transportation segment (oil and gas, power generation, etc.), as well as a sizable resource industries (mining) business.

Each segment that Caterpillar serves is cyclical. But when combined across different geographies, Caterpillar’s business is far more diversified than other pure-play industrial companies.

This table shows Caterpillar’s 2022 revenue by segment and geography:

Notice that no single segment or geographic region makes up more than 50% of revenue. In fact, most of Caterpillar’s sales come from outside of North America. What’s more, each region brings its own value to the table. Outside of North America, EMEA brings in a lot of construction and energy and transportation revenue, while Latin America and Asia/Pacific generate a large share of the mining business.

Caterpillar’s diversification allows it to absorb downturns in certain industries or in certain regions. Granted, there are times like in 2020 when all of Caterpillar’s segments across its regions were getting hit at the same time. But even then, Caterpillar’s balance sheet gave it the dry powder needed to pay and raise the dividend and outlast that downturn.

2. Home Depot rewards its shareholders
Home Depot was added to the Dow index in 1999 during a major reshuffling. And since then it has proven it deserves a place there. On Jan. 1, 1999, Home Depot had a market cap of $84.2 billion. Today, the business is much larger — sporting a $286.9 billion market cap.

Like Caterpillar, Home Depot is a highly cyclical business. But while Caterpillar has a dealership network and mostly depends on business-to-business sales, Home Depot works with a combination of businesses and consumers. For that reason, Home Depot is heavily dependent on a growing economy and strong consumer spending. This dependence makes Home Depot’s performance undergo major swings based on the business cycle.

Despite this volatility, Home Depot is a cash cow that generates far more free cash flow (FCF) than it needs to cover the dividend. This chart sums up why Home Depot has been a long-term winning stock.

Just as the dividend yield is just the dividend per share divided by the share price, the FCF yield is the FCF per share divided by the share price. Notice that Home Depot’s FCF yield has been higher than its dividend yield every single year for the last decade — which has freed up cash to buy back stock. In fact, Home Depot has reduced its outstanding share count by 31.5% over the last 10 years, which permanently boosts earnings per share and makes the stock a better value.

By being a well-run, reputable brand that generates gobs of FCF, investors can count on Home Depot to pay and raise its dividend year after year, as well as swoop in and repurchase its stock on the cheap during a major market correction.

3. Johnson & Johnson: A Dividend King that is on sale
Johnson & Johnson was added to the Dow index in 1997. The company is a titan in the healthcare industry — which is often referred to as recession-proof. Similar to consumer staples and utilities, demand for healthcare is relatively unaffected by the business cycle. And for that reason, companies like J&J don’t have the cyclicity that industrial and consumer discretionary companies do.

J&J is like a consumer staple/healthcare hybrid. Unlike pure-play pharmaceutical companies or drugmakers, a big part of J&J’s business is making consumer products like Band-Aids and Tylenol. However, J&J plans to spin off its consumer health segment by year’s end, since it isn’t as profitable as its pharmaceutical or medical technology segments.

Less diversification and more growth could benefit shareholders over the long run. But it could also make the dividend a little bit less secure than in years past.

One solution is to simply hold shares of J&J stock and then also buy shares of the consumer health company once it has its initial public offering. This approach should achieve a similar level of safety as the pre spun-off company, and maybe offer even more potential upside, since J&J believes the spin-off will be accretive to generating long-term shareholder value.

When companies are undergoing historical realignments and strategic shifts, it’s common for stock prices to languish as investors take a wait-and-see approach. But given J&J’s history of dividend raises, its hearty 3% dividend yield, its reasonable valuation, and the fact that J&J stock is down 12.9% already year to date, now seems like a good time to buy shares in the Dividend King.

A motley trio of reliable, passive income-producing stocks
Caterpillar, Home Depot, and J&J are examples of safe stocks across three completely different sectors of the economy. Caterpillar achieves a margin of safety by being geographically diversified across different industries. Home Depot offsets its vulnerability to the economic cycle by generating plenty of extra cash that it can use to buy back stock. J&J is an inherently safe business with a high dividend yield thanks to a sell-off in its stock.

All three Dow Jones Industrial Average stocks are worth consideration for a diversified portfolio focused on investing in blue chip dividend stocks.

— Daniel Foelber

Where to Invest $99 [sponsor]
Motley Fool Stock Advisor's average stock pick is up over 350%*, beating the market by an incredible 4-1 margin. Here’s what you get if you join up with us today: Two new stock recommendations each month. A short list of Best Buys Now. Stocks we feel present the most timely buying opportunity, so you know what to focus on today. There's so much more, including a membership-fee-back guarantee. New members can join today for only $99/year.

Source: The Motley Fool