Buying high-quality dividend stocks and holding them for long periods can be a powerful approach to building wealth. When a stock's cash distribution is reinvested, after all, shareholders can take advantage of the magic of compounding.
Dividend-paying pharma stocks have a well-earned reputation for being some of the most potent wealth builders within the category. The core reasons are these companies operate in a high-growth industry, serve a growing and aging population, and generate enormous free cash flows every year.
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Two of the most popular dividend stocks in the large-cap pharma space are Bristol Myers Squibb (BMY 0.34%) (a.k.a. BMS) and Merck (MRK 0.37%). Which one of these major drug manufacturers is the better choice for income investors? Let's compare them on some key metrics to find out.
The case for BMS
BMS stock offers one of the richer payouts in the pharmaceutical industry, with a current yield of 4.72%. Its stock is also cheap, trading at less than 7 times forward earnings. BMS has a long history of rewarding shareholders with dividends, having increased its payout every year for the past 15 years and having paid a dividend for 92 straight years. The dividend is also well-covered by earnings, with a trailing-12-month payout ratio of around 57%.
However, BMS is poised to face some major challenges soon. The company is set to lose patent protection for its three best-selling drugs (Revlimid, Opdivo, and Eliquis) all within the current decade. These drugs account for most of the company's revenue, which has already been impacted by the launch of generic Revlimid last year. By the end of the decade, BMS will likely have to compete against knock-off versions of Opdivo and Eliquis as well.
BMS is trying to overcome these headwinds by launching a variety of new drugs and bringing in additional assets through M&A, but there is no guarantee these efforts will be enough to offset the revenue losses from its aging portfolio. Highlighting this struggle, some analysts covering the stock think BMS' top line will flatline over the next five years.
The case for Merck
With an annualized yield of 2.93%, Merck offers a higher dividend than the average S&P 500 listed stock, but slightly lower than its big pharma peer group average (3.2%). Its stock is also attractively valued at less than 13 times projected earnings. However, Merck's payout ratio of 162% raises some questions about the sustainability of its dividend. Despite its elevated payout ratio, the company has increased its payout every year since 2011, indicating management is committed to paying a top dividend.
Merck, like BMS, will face major patent challenges later this decade, namely for its immuno-oncology blockbuster Keytruda. As a result, analysts have been closely monitoring the drugmaker's pipeline progress recently. The positive news is that Merck seems to have a solid pipeline capable of overcoming this key patent loss, although more M&A may be in the cards.
Verdict
Both BMS and Merck have solid dividend payouts that provide a steady stream of income for investors, as well as decent potential for future growth. However, Merck has a slight edge over BMS in this comparison of big pharma dividend stocks. Merck is still in growth mode and it seems better equipped to deal with its upcoming bout with the patent cliff. Of course, this is a fluid situation, and new developments could alter the picture quickly. But for now, Merck looks like a better choice because of its stronger growth outlook.
