Pharma Ups the Dividend Ante

There's no way to sugarcoat this: It was not a pretty year for pharmaceutical companies.

While the S&P saw substantial gains over the last year, with the exception of Bristol-Myers Squibb (NYSE: BMY  ) and Novartis (NYSE: NVS  ) , every other major pharmaceutical company listed on the U.S. exchange saw their shares decrease. And neither of the two that were in positive territory actually surpassed the S&P 500.

The only good news is that the substantial dividend yields offered by many pharmaceutical companies made the returns look "less bad." Adding in the dividend payments brought four additional companies into the black.

Company/Index Dividend Yield 2010 Stock Price Change 2010 Dividend Adjusted Return
Pfizer (NYSE: PFE  ) 4.5% (3.85%) 0.20%
Merck (NYSE: MRK  ) 4.2% (1.45%) 2.83%
Bristol-Myers Squibb 5.0% 4.75% 8.61%
Eli Lilly (NYSE: LLY  ) 5.6% (1.93%) 3.60%
GlaxoSmithKline 5.2% (7.57%) (2.55%)
Novartis 2.8% 8.29% 11.61%
AstraZeneca (NYSE: AZN  ) 5.0% 1.91% 7.21%
sanofi-aventis (NYSE: SNY  ) 3.4% (17.77%) (14.79%)
S&P 500 1.8% 12.81% 15.03%

Source: Capital IQ, a division of Standard & Poor's, and Yahoo! Finance.

Getting paid to wait
Pharma doesn't have much going for it at the moment. New blockbusters are few and far between, but current blockbusters going off patent are everywhere. Pfizer is losing Lipitor, Bristol-Myers and Sanofi are losing Plavix, Merck recently lost blood-pressure pills Cozaar and Hyzaar, and the list goes on.

Fortunately, investors can usually see the loss of sales from generics coming. That's the reason you see Eli Lilly trading at an adjusted P/E of eight. The recent financials would make you think it should deserve a higher valuation: revenue, for example, grew 8.1% year over year in the trailing 12 months. But investors have rightfully priced in the upcoming loss of Zyprexa, Gemzar, Humalog, and Cymbalta.

At some point, the research-and-development tides will turn, drugmakers will have fallen completely off their patent cliffs, and investors will be able to watch top- and bottom-line growth turn into substantial increases in share prices.

For now, though, investors will have to be content collecting their dividends while they wait.

A good sign
This month, both Pfizer and Bristol-Myers Squibb boosted their dividends.

Pfizer's 11% dividend increase was a welcome sign after its dividend was cut in half when Pfizer decided to buy Wyeth. The $0.20 per share each quarter is still well under the $0.32 per share investors were getting before the acquisition, however.

Bristol made a token $0.01 per share raise in its quarterly dividend. While it doesn't amount to that much for investors, the drugmaker will end up shelling out an extra $17 million each quarter.

In my book, the added distribution is a good sign because it says management is confident about its cash flow, and specifically its cash flow in U.S. dollars. Multinational pharmaceutical companies leave foreign profits with their offshore subsidiaries in order to avoid paying U.S. tax. That's all fine and good until the company needs to pay dividends to U.S. shareholders. Repatriating that cash can cost companies a pretty penny.

If one of the main reasons you're holding a pharmaceutical company is because of the substantial dividend payments, then knowing that they'll keep being there -- and perhaps be even larger -- is a good sign.

Juice those returns
Assuming you don't see the share prices zooming up anytime soon -- I certainly don't -- pharmaceutical companies offer the perfect opportunity to increase the income you derive from owning the shares through selling covered calls.

By selling a covered call and collecting the premium, you can obtain income beyond dividends. Of course, you give up potential upside since you agree to sell the shares at a certain price, but the trade-off may be worth the added income.

2011 and beyond
The pharma turnaround isn't going to happen overnight. Unless you're planning on holding for the extended future, I'd look elsewhere. If you do decide to buy, you might as well enjoy the dividend and perhaps some covered call income as well.

Brian Richards lays out the five fastest dividend growers of the past decade.

Pfizer is a Motley Fool Inside Value pick. GlaxoSmithKline and Novartis are Motley Fool Global Gains recommendations. The Fool owns shares of and has written covered calls on GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.


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