Any way you look at it, Pfizer (PFE -0.19%) appears to be a great dividend stock. The big drugmaker's dividend yields north of 3%. Income-seeking investors have loved Pfizer for years.
But appearances can sometimes be deceiving. It's a good idea to test your assumptions about a stock before investing -- and even after investing. Just how safe is Pfizer's dividend?
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Two critical components
A stock must have two critical components for its dividend to be reliably considered safe. First, the company must be able to generate sufficient earnings to fund the dividend at least at current levels for the foreseeable future. Second, the company's management must be committed to allocating capital to funding dividends at least at current levels.
Note that these two criteria hinge on a company's ability and motivation to keep paying dividends at least at current levels and not on merely paying a dividend. Many companies have paid attractive dividends only to cut their payouts to much less attractive levels. We wouldn't view those dividends as safe.
Also, keep in mind that we can't just look at a company's past. Sure, a good track record of paying dividends is helpful, but the future for a business can turn out much different than its past. That's especially true for biopharmaceutical stocks given the constantly changing dynamics in the industry.
Rating Pfizer's ability to fund its dividend
The most commonly used metric to evaluate a company's ability to pay dividends is its dividend payout ratio. This number reflects the company's annual dividend payments divided by its annual earnings. Generally speaking, a healthy dividend payout ratio will be less than 50%.
So what is Pfizer's dividend payout ratio? Only 35.4%. This means that the big drugmaker is using just a little more than one-third of its earnings to fund its dividend program. That gives Pfizer a lot of leeway to keep paying dividends at current levels even if its earnings decline.
And that leads us to the next question: What are Pfizer's future earnings prospects? If the company's earnings are likely to fall significantly over the next few years, the safety of its dividend could be suspect.
Pfizer expects to deliver double-digit adjusted earnings-per-share growth through 2025, excluding any impact from its COVID-19 programs. The problem, though, is that the company's COVID-19 vaccine Comirnaty and COVID-19 pill Paxlovid combined currently generate well over half of Pfizer's total revenue. Sales of these products could potentially sink, which would negatively impact the company's earnings.
The next few years could be especially challenging for Pfizer. The company faces the loss of exclusivity for several of its top-selling products, including Eliquis, Ibrance, Vyndaqel/Vyndamax, Xeljanz, and Xtandi. But Pfizer has new products that could help offset these losses, notably including the potential blockbuster autoimmune-disease drug etrasimod.
Still, there doesn't seem to be any reason for concern about Pfizer generating enough earnings to continue funding its dividend at least at current levels for a long time to come. It's possible that dividend increases could be lower than in the past as the drugmaker deals with its looming patent cliff. However, Pfizer deserves a solid rating on this criterion.
Rating Pfizer's commitment to fund its dividend
Evaluating a management team's commitment to funding the dividend at least at current levels is admittedly subjective. Corporate executives and boards of directors often change directions.
However, past records do matter on this front. Pfizer has paid a dividend for an impressive 334 consecutive quarters and has increased the dividend for 12 consecutive years. Company management frequently highlights the importance of using capital to fund dividends.
Pfizer knows that the dividend is an important part of the reason many investors buy its stock. Unsurprisingly, "commitment to dividend" is one of four priorities in the company's capital allocation framework. Pfizer merits a high rating on this criterion as well.
How things could change
The bottom line is that Pfizer's dividend appears to be quite safe. Pfizer's ability to fund the dividend at least at current levels should remain strong for years to come despite some looming headwinds from patent expirations. The company's commitment to its dividend also seems rock solid.
Could this change in the future? It's possible. There are two scenarios in which Pfizer's dividend could be in jeopardy.
The company could experience a string of pipeline failures. Pfizer depends on launching new products to make up for declining sales of older products. Too many flops could threaten the drugmaker's ability to pay dividends down the road. This scenario is unlikely, though. Pfizer claims one of the best clinical trial success rates in the biopharmaceutical industry in recent years.
The more likely scenario that could cause a dividend cut is a merger, acquisition, or divestiture. Pfizer last slashed its dividend in 2009 to help fund the acquisition of Wyeth. The company also initially expected to reduce its dividend following the spinoff of Viatris in late 2020. However, soaring revenue and earnings from Comirnaty allowed Pfizer to avoid a dividend cut.
