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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.
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.