Dividend investors sometimes fixate on a stock's yield to judge its greatness as an income investment. But that number is only part of the story, and arguably not the most important part.
A high dividend payout may simply mean that the company is prioritizing returning its cash flow to investors over reinvesting that cash in the business to produce growth. That could be appropriate for some mature or regulated businesses that have limited growth opportunities. But the best dividend stocks have a growth component, and investors will build more wealth in the long run by choosing companies that are balancing growth investments with payouts to shareholders.
Does pharmaceutical giant AbbVie ( ABBV -1.09% ) measure up as a great dividend stock? Let's look at both the size of its dividend and the company's ability to grow it in the future.
Sustainable business growth
Over time, a company will be able to grow its dividend no faster than it can grow the cash flow that the business generates. Pharmaceutical companies generally commit significant portions of their profit to expanding their portfolios of drugs, either through innovation from their research and development departments or through acquisitions. AbbVie is doing both, but investors have been concerned about a headwind from generic competition to Humira, the world's top-selling drug, which will likely appear in the U.S. in 2023.
Humira contributed about 40% of AbbVie's sales in the latest quarter, so the market's worry is valid. But that business won't disappear immediately. Humira has already lost exclusivity outside the U.S. and international sales fell only 8% in the first three quarters of this year. And the company has been working for years to prepare for the challenge, developing next-generation replacements for Humira that appear to be superior. AbbVie has also been making acquisitions to decrease its reliance on Humira, most notably buying Allergan, maker of Botox and some promising neurological drugs.
Meanwhile, AbbVie's portfolio, helped by some potential cancer drugs that are still in early days, is generating piles of cash that support the generous dividend while allowing the company to invest in growth. Operating cash flow in the first nine months of 2020 grew 27% to $12.7 billion. The company is investing about 13% of revenue in research and development, which it thinks will pay off with the approval of over a dozen new products or indications in the next two years.
AbbVie split from Abbott Laboratories about eight years ago, but by virtue of the dividend history of its parent company, it earns the designation of Dividend Aristocrat. The company is unlikely to do anything to jeopardize that 47-year history of dividend increases.
In fact, the split turbocharged AbbVie's ability to grow its payout. The quarterly dividend has tripled since AbbVie's first payment to shareholders in January 2013. The company hiked its dividend another 10.2% last month after a 10.3% increase in 2019 and an 11.5% boost in 2018.
High current yield
Often stocks with rapidly growing dividends have lower yields because investors who value that growth are willing to trade off current yield to get it and bid up the stock price. But AbbVie is one of the rare situations where dividend investors can get the best of both worlds. After the latest boost to the payout, the stock yields 5%, which makes it one of the best high-yield opportunities available now.
And AbbVie should have no trouble maintaining that dividend and continuing to grow it. Dividends paid this year so far have amounted to only 46% of the company's free cash flow, giving it plenty of margin to make payouts and invest for growth regardless of challenges ahead.
AbbVie ticks the boxes when it comes to dividend greatness, a conclusion apparently shared by Warren Buffett, who added the stock to Berkshire Hathaway's portfolio last quarter. The stock might bounce around as investors worry about Humira sales losses or the politics of drug pricing. But the company has the wherewithal to keep those dividend payments growing despite the challenges, and investors would do well to make the shares a core holding of a dividend portfolio.