Dividend-paying pharmaceutical stocks have an outstanding track record of producing market-beating returns on capital. The core reason is that major drug manufacturers tend to generate enormous free cash flows, leading to exceptionally rich dividend programs. Keeping with this theme, big pharma stocks sport a handsome 3.08% average dividend yield, which compares rather favorably to the 1.56% average yield among S&P 500 stocks.
Not all dividend-paying pharma stocks are market slayers, however. Over the past 10 years, British pharma giant GSK (GSK 0.49%) has dramatically underperformed most of its big pharma peers as well as the broader markets. The good news is that GSK's outlook has brightened significantly since the carve-out of its consumer healthcare unit Haleon last year.
GSK Total Return Level data by YCharts
Is its stock a strong buy right now?
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GSK's outlook, valuation, and dividend
GSK's core areas of expertise are infectious diseases, respiratory diseases, immunology, and oncology. The company's branded pharma portfolio has been performing admirably from a commercial standpoint of late. In the most recent quarter, total sales rose 10% operationally relative to the same period a year ago, when excluding the anticipated decline in pandemic solution products. A significant chunk of this top-line growth was driven by the shingles vaccine Shingrix, longer-acting HIV treatments like Cabenuva, and key respiratory medicines such as Trelegy.
The drugmaker's late-stage pipeline and business development activities have also been bearing fruit. GSK is waiting to hear back from the Food and Drug Administration (FDA) about its regulatory filing for the myelofibrosis drug momelotinib. Its newly acquired phase 3 cough treatment, camlipixant, has blockbuster sales potential and it recently won FDA approval for respiratory syncytial virus vaccine Arexvy. Arexvy is forecast to haul in nearly $2 billion in annual sales at peak, according to analysts' estimates.
The drugmaker also isn't facing a parade of major patent expires this decade. Newer growth products like Arexvy, Cabenuva, and possibly camlipixant (assuming approval) should thus be able to drive respectable levels of bottom- and top-line growth in the years ahead.
GSK does have some important weaknesses as an investment vehicle, however. Chief among them is the lack of a clear-cut all-star in areas like cancer, rare diseases, or metabolic disorders. Top-selling cancer and rare disease medications often drive premium stock valuations due to their built-in pricing power. Metabolic disorder drugs, on the other hand, tend to be premium value drivers as a result of their large target markets. GSK does have assets in these areas, but none that rise to the top of the field.
Speaking of valuation, GSK stands out as a relatively cheap big pharma equity. With an earnings yield of 7.64%, GSK's shares are undervalued relative to its big pharma peers (average earnings yield of 7.2%), as well as a risk-free asset such as a 10-year U.S. Treasury note.
GSK's equity has failed to earn a top-tier valuation due to its balanced approach to growth (no high-profile flagship product driving double-digit sales growth), along with the ongoing litigation over gastroenterology drug Zantac.
On the dividend front, GSK presently offers a 3.8% annualized dividend yield. Its dividend is well covered by earnings, evinced by its modest 56.3% trailing-12-month payout ratio. Additionally, management has shown an exceptional level of dedication to paying a top-tier dividend in recent years despite a host of headwinds. Hence, GSK's dividend screens as a dependable source of passive income.
Is GSK a top buy right now?
GSK ought to produce steady levels of passive income for shareholders over the next several years. As a bonus, its moderately undervalued shares should heat up once this Zantac overhang is firmly in the rearview mirror.
GSK thus comes across as a compelling buy for passive income and value investors alike. Growth investors, however, may want to look elsewhere. Without a flagship product in top indications like cancer, NASH, or a white space rare disease, this big pharma stock probably won't deliver market-beating returns anytime soon.
