Dividends Aren't Enough: Biotech

I love cash. As an investor, nothing makes me happier than a company that returns money to shareholders, rather than spending it recklessly on a CEO's pet projects or an ill-fated acquisition. Historically, investors have often looked at a stock's dividend yield to identify these shareholder-friendly enterprises. But I prefer a slightly different metric -- one proven to further maximize investor returns.

A 2007 study in The Journal of Finance suggests that investors should also factor net share repurchases into the equation, through a metric called the net payout ratio. According to the authors of the study, this ratio not only identifies companies that are paying back investors, but also predicts future equity returns better than the dividend yield.

Let's crunch the numbers
To find the net payout yield, start by adding up all the cash the company spends on both dividends and share buybacks. Next, subtract its share issuances. Finally, divide the resulting number by the company's current market cap.

The ratio that you end up with represents the percent of each invested dollar that a company is returning to shareholders. This simple calculation handily allows us to adjust for shares issued through employee stock options and other forms of shareholder dilution. Some companies will spend a lot of money buying back shares just to counteract the dilutive effect of their stock compensation programs, without creating any value for shareholders.

Here are the net payout yields for a few companies in the biotechnology industry:

Company

Net Payout Yield (TTM)

Dividend Payments (TTM)

Net Share Repurchases (TTM)

Market Cap

Gilead Sciences (Nasdaq: GILD  )

7.5%

 $0

 $2,119

 $28,316

Amgen (Nasdaq: AMGN  )

6.5%

 $0  

 $3,383

 $51,892

Genzyme (Nasdaq: GENZ  )

7.1%

 $0  

 $1,201

 $17,026

Biogen Idec (Nasdaq: BIIB  )

16.2%

 $0  

 $2,216

 $13,673

Dendreon (Nasdaq: DNDN  )

(8.9)%

 $0  

 $(490)  

 $5,517

Source: Capital IQ, a division of Standard & Poor's. Payout yield is author's calculation. All dollar figures in millions. TTM = trailing 12 months. Data as of close of Aug. 18.

Because of the nature of biotech companies, they rarely pay dividends. In fact, none of the above pay one, so the net payout yield is due exclusively to net share repurchases.

How powerful is this payout?
Based on the analysis above, with the exception of Dendreon, all the companies look like potential buys for investors searching the biotechnology industry for a stock with a net payout yield.

Keep in mind that this data only looks at trailing-12-month numbers, so it does not correct for recent changes in a company's dividend or buyback policy. While dividends tend to remain fairly stable, share buybacks can vary substantially from year to year. Investors should also look at a company's dividend payout ratio to make sure the dividend is sustainable, and examine historical buyback patterns to ensure that the buybacks aren't a one-time event. If you can build a diversified portfolio with a few of these high-yielders, healthy returns -- and plenty of that cash -- are likely to follow.

Motley Fool Hidden Gems analyst Jeremy Myers does not own any of the companies mentioned. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (0)

Comments from our Foolish Readers

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  • Report this Comment On August 20, 2010, at 10:26 PM, thecannula wrote:

    N-E-U-V-E-N-G-E- hear of it?

    DENDREON CONFERENCE CALL REPORTING $5 MILLION PROVENGE EARNINGS IN JULY-

    “The IND for Neuvenge is active and we’ve already completed two Phase I clinical studies in Neuvenge, both in the breast cancer setting and also in the ovarian and colorectal cancer setting. So, what we are evaluating right now is exactly what disease state we take Neuvenge into and what would those clinical trials look like. And certainly that will be the topic of discussions with the FDA, but internally we haven’t fully decided where we are going to take Neuvenge from a disease setting as of now. Once we conclude on that, we’ll share that with you.”

    STRONG BUY AND HOLD

  • Report this Comment On August 21, 2010, at 8:20 PM, getrickqk wrote:

    More "FUD" on Dendreon. Writer must be a short seller! LOL!

  • Report this Comment On August 22, 2010, at 11:36 AM, thecannula wrote:

    breast cancer vaccine?

    bladder cancer vaccine?

    colon cancer vaccine?

    can't happen?

    prostate cancer vaccine has happened and 13/14 Medicare carriers and private ins are paying for it

  • Report this Comment On August 23, 2010, at 8:26 PM, getrickqk wrote:

    Yes folks, the Motley Fool's writers are running out of negative ideas to write about Dendreon. Now the false analogy about dividend payouts! Right now Dendreon should be considered only for hyper-growth investing goal and not be compared to more mature Biotechs such Amgen, Gilead Science and others where clearly they have curve themselves a market share for their different lines of drugs, with predictable revenues and earnings. Provenge is FDA approved and most other risk like coverage is overstated. Clearly the 5-10X ROI is possible in a few years with all 3 plants near completion and possibly operational early next year.

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