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2 Pharmaceutical Dividends to Buy and 1 to Avoid

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Buying into the pharmaceutical sector is like driving in the fast lane on the freeway. You're guaranteed a healthy gross margin and a fast-track to profits, but eventually you'll be caught speeding and the patent expiration cliff could send you straight to jail without passing go and collecting $200.

The secret to spotting true values in this sector lies in finding companies that have diversified drug portfolios and a history of dividend increases. Although seeking out pharmaceutical companies that meet these criteria doesn't guarantee success, the handsome dividends that these companies provide should give you above average returns. Here are two pharmaceutical dividends you can trust and one you might be better off avoiding.

Johnson & Johnson (NYSE: JNJ  ) : Trust it
Although Johnson & Johnson is more of a medical conglomerate -- manufacturing medical devices and diagnostic services as well drugs -- it would be truly foolish to not include arguably the strongest dividend in existence. The last time Johnson & Johnson's quarterly dividend fell was 1976, and in the 35 years since then, the company's dividend has grown by a mouth-watering 10,265%!

Johnson & Johnson provides consumers with everything from Tylenol to groundbreaking cancer therapies while maintaining a well-diversified, investor-friendly drug portfolio. Slated to grow at 6% annually over the next five years and with a very sustainable dividend payout ratio of 50%, J&J looks like a stock you can trust for the long-term.

Teva Pharmaceutical (Nasdaq: TEVA  ) : Trust it
Last month I anointed Teva Pharmaceutical as pharma's most impervious pipeline because of its position as the world's largest producer of generic drugs. For pharmaceutical juggernauts Eli Lilly (NYSE: LLY  ) , AstraZeneca (NYSE: AZN  ) and GlaxoSmithKline (NYSE: GSK  ) , who are all facing huge patent expiration cliffs within the next few years, Teva represents the greatest threat to their revenue streams.

But it's not just Teva's literally thousands of pending drug approvals that make it an attractive play. The company has rewarded shareholders with countless dividend increases in the last decade, amounting to more than a 1200% jump in its quarterly payout. Teva's five-year growth rate of 11% coupled with its rapidly rising dividend makes this a dividend play you can trust.

Pfizer (NYSE: PFE  ) : Avoid it
Pfizer is a double-edged sword in that it provides investors with a huge drug portfolio, but it's also facing one of the steepest patent cliffs of the sector. The best selling drug in the world, Lipitor, is set to come off patent protection this year, and the company is set to lose other blockbusters, notably Viagra and Celebrex in 2012 and 2014, respectively.

Perhaps even more worrisome is the sustainability of Pfizer's current dividend. Don't get me wrong, a 3.8% yield is attractive, but considering that Pfizer's quarterly payout has dropped by 38% since early 2009, and its payout ratio has climbed to 72%, there's call for concern. This looks like a situation and a dividend I'd avoid altogether.

Foolish thoughts
There's more to the pharmaceutical sector than just picking high-yielding dividends. Pipeline longevity and drug portfolio diversity are important factors to consider and should make Johnson & Johnson and Teva solid choices for long-term growth.

What are some of your favorite dividend plays from the pharmaceutical sector? Share your choices in the comments section below, and consider tracking Johnson & Johnson, Teva Pharmaceutical, and Pfizer, as well as your own personalized portfolio of stocks with My Watchlist.

The Fool has written covered calls on GlaxoSmithKline, and owns shares of Johnson & Johnson, Teva Pharmaceutical and GlaxoSmithKline. Motley Fool newsletter services have recommended Johnson & Johnson, Pfizer, GlaxoSmithKline, and Teva Pharmaceutical. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He would like to remind you not to forget about our friends in Japan who could still use a helping hand. You can follow him on CAPS under the screen name TMFUltraLong. 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. The Motley Fool has a disclosure policy that's drugged up on transparency.

Read/Post Comments (5) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 16, 2011, at 11:33 AM, financeguy85 wrote:

    I'm not quite sure who I should be addressing, Mr. Jayson or Mr. Williams. In any event, thanks for the insight into pharmaceuticals dividends. A few things came to mind when reading. One, I think you may be too harsh on Pfizer. The company only had to cut its dividend because of its massive purchase of Wyeth a few years ago. Other than that, its dividend has grown quite nicely, and their product portfolio is now more diversified and has a number of drugs in advanced clinical trials. I like Teva, but the yield below 2 percent is not very attractive for income seekers. Also consider that if the company is based in Israel, those dividends face a 20 percent tax, making it even less attractive.

  • Report this Comment On May 16, 2011, at 12:16 PM, gcmagone wrote:

    I am basically an income seeker,so the tax does hurt. However, I really need to diversify a little into the health sector. So, all things considered, I have picked TEVA. Their growth prospects in generic drugs. This will go along with my pick of HCP for their leading position in medical real estate.

  • Report this Comment On May 16, 2011, at 12:26 PM, interd0g wrote:

    Dividend increasers seem to be flavor of the month, but I don't feel it.

    If you have, for example a 1.25% dividend but increase it by, say, 15% per year, it will take you about 14 years to catch up with the guy who already delivers 5%. All that while you have a miserable income.

    Unless you plan on living forever, I say start off with a decent dividend in the first place.

  • Report this Comment On May 16, 2011, at 9:28 PM, romanson3625 wrote:

    Teva is the only one with a decent dividend and a great growth rate.

    I wouldn't put it past one of these major pharmaceutical companies to try and take them out over the next few years.

  • Report this Comment On May 21, 2011, at 2:18 AM, TMFUltraLong wrote:

    To add another twist to this article... re-read the first paragraph and then take note that less than 10 hours after writing that I received a speeding citation..... *smirk*...


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