Better Dividend Stock: Merck & Co. Inc. or Bristol-Myers Squibb Co.?

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Dividend stocks are arguably the most critical component to the success of any long-term investor. According to the latest statistics from FactSet, S&P 500 companies paid out a whopping $91.5 billion in dividends during the second quarter, or an extrapolated pace of $366 billion per year.

But not all dividend stocks are created equally, which means you must be somewhat discerning when researching the more than 1,900 small-cap and larger companies that have paid a dividend within the past 12 months.

How do you weed out the good from the bad, you ask? The answer is to dig beyond the dividend yield itself and look at the company behind the payout. Once you've judged the growth, value, and sustainability of the business, you'll have a better bead on whether you should consider a dividend as high quality or not.

Within the healthcare sector, for example, dividends are already somewhat rare, so investors who spot any yield could be liable to chase it. Sometimes that can be a very bad choice. That's why today we're going to pit Merck (MRK 0.10%) against Bristol-Myers Squibb (BMY -0.27%) to decipher if both companies are worthy of investors' dollars and to determine which is the better dividend stock.

Growth
The first thing investors need to establish when analyzing a dividend stock is whether the company has genuine sales and profit growth potential. A company that can't grow its sales or profits will find it difficult, if not impossible, to grow its dividend.

As with most big pharmaceutical companies, both Merck and Bristol-Myers Squibb present a mixed case of growth, as newly approved therapies and acquisitions are being counted on to offset patent exclusivity losses.

Merck is already dealing with the loss of patent exclusivity for asthma blockbuster Singulair, which previously brought in up to $5 billion per year in sales, as well as brain cancer drug Temodar. Worse yet, Merck's cholesterol-lowering drugs Zetia and Vytorin will face generic competition within the next three years, and they're both on pace to contribute about $4.5 billion in revenue this year. 

Source: Bristol-Myers Squibb.

Since 2012, Bristol-Myers Squibb has witnessed generic competition step up against previous blood pressure blockbuster Avapro, blood thinner Plavix, and HIV treatment Sustiva. By 2015, Bristol-Myers will also be staring down the exclusivity loss of schizophrenia drug Abilify, which is on pace to deliver close to $1.5 billion in total U.S. sales this year.

Of course, each company also has plenty of promise. Perhaps the most interesting comparison that can be made between the two is that they're both heavily focused on their hepatitis C and anti-PD-1 inhibitors.

While arguably light years behind Gilead Sciences' (GILD 0.07%) Sovaldi, which racked up in excess of $5 billion in sales through its first two reported quarters on the market, both Merck and Bristol-Myers have promising hepatitis C drugs in development.

Merck's combo of MK-5172 and MK-8742 delivered a 98% sustained virologic response after 12 weeks, according to data released in April. Inclusive of its Idenix Pharmaceuticals acquisition, Merck could have a number of hepatitis combo offerings. Bristol-Myers, in addition to developing in-house hepatitis C drugs, has swallowed its pride and gone with the "if you can't beat them, join them" approach. Its drug daclatasvir looks as if it could be a fantastic combo fit with Gilead's Sovaldi.

In anti-PD-1 inhibitor cancer therapies, Merck received accelerated FDA approval on advanced melanoma drug Keytruda four weeks ago. Chances are good that an approval for Bristol-Myers' Opdivo isn't far behind. Both drugs dramatically improved survival rates and overall response rates in clinical studies and have an opportunity to expand to a number of additional solid tumor indications.

Despite this extremely close battle, I'm giving this category to Bristol-Myers by a nose since it is expected to produce higher revenue growth over the next five years than Merck.

Value
Dividend investors like to feel as if they're getting good value when purchasing a dividend stock. Under normal circumstances, looking at financial metrics in the healthcare sector is pointless since so many companies are in the clinical stage of their product development. However, Merck and Bristol-Myers have well-established product pipelines and cash flow, so a comparison could actually yield differentiated and meaningful results.

Here are some pertinent data points for these two pharmaceutical stocks:

Source: Yahoo! Finance. TTM = trailing 12 months.

Would we really have expected anything other than mixed data?

Source: Merck.

On one side of the coin, Bristol-Myers Squibb is clearly going to grow faster than Merck (thus its low PEG ratio), has a modestly better trailing profit margin, and has a much more enticing net debt position. Conversely, Merck is cheaper than Bristol-Myers when it comes to price-to-sales and is significantly cheaper on a forward P/E basis.

Considering that growth prospects were so close in the prior category, after weighing both sides I've determined Merck to be the slightly better value with strong cash flow and a low P/E ratio. It could be five years before Bristol-Myers' forward P/E dips below 20.

Sustainability
This means the battle for which is the better dividend stock comes down to sustainability -- and not only sustainability of the dividend, but of the business model over the long term. Admittedly, it's tough to decipher how well or poorly a pharmaceutical company will be doing 30 years down the road, but it's not out of the question to look 10 years ahead in order to analyze these businesses.

Though both companies are clearly facing patent cliff concerns, I also believe they have the internal tools and ability to make accretive acquisitions to counteract these revenue losses over time. The real question is which company is most likely to deliver better dividend growth over time.

BMY Dividend data by YCharts.

At the moment, Merck's 3.1% dividend yield and Bristol-Myers' 2.9% yield are very similar. Yet there's one major difference: payout ratio. Bristol-Myers is projected to pay out 83% of its earnings in the form of a dividend to shareholders in 2015. Merck's figure is just 49%. Though Bristol's EPS growth is expected to pick up in the second half of the decade, this would leave Merck as the more likely of the two to grow its dividend at the quickest pace.

The better dividend stock is...
Though Merck and Bristol-Myers Squibb have quite a few similarities, and both would probably make reasonably good additions to a dividend income portfolio, Merck appears to be the better dividend stock. While Merck's revenue growth might struggle in the near future, its ability to cut costs and its focus on hepatitis C and cancer treatments should allow it to continue to deliver a dividend yield of approximately 3% or higher for many years to come.