Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as fetching as they may appear. Let's see which companies in the pharmaceutical industry offer the most promising dividends.
Yields and growth rates and payout ratios -- oh, my!
Before we get to those companies, though, you should understand just why you'd want to own dividend payers. These stocks can contribute a huge chunk of growth to your portfolio in good times, and bolster it during market downturns.
As my colleague Matt Koppenheffer has noted: "Between 2000 and 2009, the average dividend-adjusted return on stocks with market caps above $5 billion and a trailing yield of 2.5% or better was a whopping 114%. Compare that to a 19% drop for the S&P 500."
When hunting for promising dividend payers, unsophisticated investors will often just look for the highest yields they can find. While these stocks will indeed pay out the most, the yield figures apply only for the current year. Extremely steep dividend yields can be precarious, and even solid ones are vulnerable to dividend cuts.
When evaluating a company's attractiveness in terms of its dividend, it's important to examine at least three factors:
- The current yield
- The dividend growth
- The payout ratio
If a company has a middling dividend yield, but a history of increasing its payment substantially from year to year, it deserves extra consideration. A $3 dividend can become $7.80 in 10 years, if it grows at 10% annually. (It will top $20 after 20 years.) Thus, a 3% yield today may be more attractive than a 4% one, if the 3% company is rapidly increasing that dividend.
Next, consider the company's payout ratio, which reflects what percentage of income the company is spending on its dividend. In general, the lower the number, the better. A low payout ratio means there's plenty of room for generous dividend increases. It also means that much of the company's income remains in its hands, giving it a lot of flexibility. That money can fund the business's expansion, pay off debt, buy back shares, or even buy other companies. A steep payout ratio reflects little flexibility for the company, less room for dividend growth, and a stronger chance that if the company falls on hard times, it will have to reduce its dividend.
Peering into pharmaceutical companies
I've compiled some of the major dividend-paying players in the pharmaceutical industry (and a few smaller outfits), ranked according to their dividend yields:
|
Company |
Recent Yield |
5-Year Average Annual Dividend Growth Rate |
Payout Ratio |
|---|---|---|---|
|
GlaxoSmithKline (NYSE: GSK) |
5.3% |
3.2% |
75% |
|
Bristol-Myers Squibb (NYSE: BMY) |
4.1% |
0.7% |
124% |
|
Novartis (NYSE: NVS) |
4.1% |
17.9% |
70% |
|
Eli Lilly (NYSE: LLY) |
4% |
2.7% |
53% |
|
AstraZeneca |
3.9% |
10.2% |
45% |
|
Sanofi |
3.8% |
8.5% |
48% |
|
Merck |
3.7% |
0.9% |
77% |
|
Pfizer (NYSE: PFE) |
3.6% |
(8.4%) |
67% |
|
Johnson & Johnson |
3.4% |
7.8% |
77% |
|
Abbott Laboratories (NYSE: ABT) |
3.1% |
9.4% |
48% |
Data: Motley Fool CAPS.
Dividend investors typically focus first on yield. GlaxoSmithKline and Bristol-Myers Squibb are among the highest-yielding stocks on the list, but they're not necessarily your best bets. GlaxoSmithKline's dividend growth rate, for example, is rather low, and Bristol-Myers Squibb's rate is even lower – with a payout ratio revealing that the company is paying out more than it's earning.
Instead, let's focus on the dividend growth rate first, where Novartis leads the way. Its growth rate is so steep, though, that it may be hard to maintain for long. It can be helpful, too, to dig deeper into the numbers. Pfizer(PFE -0.12%), for example, sports a negative five-year growth rate, after halving its payout back in 2009. But it has been raising the dividend since then, at an 11% average annual rate over the past three years. The company has many drugs in its pipeline, but it's also facing losses from patent expirations.
Some pharmaceutical companies, such as Neurocrine Biosciences (NBIX -0.52%) and Pacira Pharmaceuticals (PCRX -2.50%), don't pay dividends at all. That's because smaller or fast-growing companies often prefer to plow any excess cash into further growth, rather than pay it out to shareholders. Both of these companies have market capitalizations of around $500 million. Neurocrine has been posting triple-digit revenue growth rates in recent years but is free-cash-flow negative and has been upping its share count considerably. Much of its revenue comes from Abbott Labs(ABT -0.59%), for its development work on an endometriosis drug, Elagolix. Pacira is busy working on expanding the approved scope of its pain-relieving drug, Exparel, but it has taken some hits because of Europe's call for a recall of one of its drugs and Novo Nordisk's (NYSE: NVO) termination of an agreement with Pacira.
Just right
As I see it, Novartis offers the best combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future. It's also highly rated in our CAPS community.
Many of the other companies are attractive, too. You might, for example, consider Eli Lilly(LLY -0.64%), for its substantial dividend yield, or Abbott Labs, for its strong recent dividend growth. Lilly is dealing with some drugs' slowing sales, as well as facing income losses from patent-protection expirations. There are many drugs in its pipeline, though, and some big wins there could change the picture, thought it might take a while. Abbott investors should be aware of an imminent split-up, as the company separates it pharmaceutical division from its nutrition and medical devices businesses.
Of course, as with all stocks, you'll want to look into more than just a company's dividend situation before making a purchase decision. Still, these stocks' compelling dividends make them great places to start your search, particularly if you're excited by the prospects for this industry.
Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.
