Passive income investors know that when there's a business that's proven to throw off a lot of cash consistently over time, it might be a good idea to hold its shares to capture safe and reliable dividends for the long haul. Novo Nordisk (NVO 0.10%) is an obvious candidate to consider right now.
Thanks to its blockbuster drug Ozempic and a pipeline that's chock-full of other potential winners, Novo Nordisk seems to have most of the makings of a great dividend stock. Let's evaluate this stock in closer detail to determine whether it's the passive income solution you've been searching for.
NYSE: NVO
Key Data Points
Novo Nordisk's ascent is in full swing...
The general case for investing in Novo Nordisk is that it's practically printing money thanks to its medicines for type 2 diabetes, obesity, and other illnesses. In Q2 it raked in more than $2.8 billion in net income, up 101% from five years ago, and it shows no sign of stopping. In fact, demand for Ozempic has been so high for more than a year that the drug was in a state of shortage in the U.S., prompting the company to halt onboarding of new patients until there was sufficient supply to continue treating the existing group. With so much visible success and the surrounding buzz, it's no surprise that the stock is up by 165% in the last three years. It's now investing more than $4 billion annually to build out its manufacturing facilities to ensure that it can meet demand moving forward.
With strong demand and earnings growth, it's also no surprise its dividend payout ratio is only 41%. A low payout ratio, rapidly growing earnings, and an ongoing effort to expand the indications that Ozempic is approved for mean that the dividend is in no danger whatsoever of being cut anytime soon or in the foreseeable future. And for dividend investors, that's a massive plus. It also supports the idea of the stock being a good investment for exposure to growth in the form of share price appreciation.
But the case for Novo Nordisk being a good purchase specifically for generating passive income more or less ends right there.
...but that doesn't make it a smart pick for dividends
There are a few reasons that Novo Nordisk is not actually a good choice for generating passive income from dividend payments at the moment. First, regular share repurchases appear to be a higher priority for management than hiking dividends, though it does plan to keep slowly increasing its payout. Repurchases support higher stock prices, but they also serve to keep the dividend yield relatively low. Take a look at this chart:
NVO Free Cash Flow data by YCharts
Trailing 12-month (TTM) spending on stock buybacks increased much faster than the TTM dividends paid, even during the last five years, when free cash flow (FCF) more than doubled, reaching $9.7 billion. Even as its FCF continues to climb thanks to high demand for its best-selling medicines like Ozempic and Wegovy, there isn't much reason to expect a major change in capital allocation in favor of more cash distributions. As popular as those medicines are, they won't be protected by Novo's intellectual property claims forever, so management needs to be somewhat conservative with commitments to capital distribution in the long term. There also isn't any precedent for the company to pay a special dividend, and even if it did, it wouldn't necessarily be repeated in the future.
If you invested $5,000 in Novo Nordisk stock today, it'd earn you $55 annually given its forward dividend yield of roughly 1.1%. That's a huge amount of money to commit for a small annual cash return. Its dividend yield is low at the moment due to the stock's sharp run-up in recent history, and given that there is unlikely to be a significant stock price pullback anytime soon on that front, there probably will not be opportunities to buy its shares with a higher yield than they have right now. In fact, the higher level of share repurchasing activity may even accelerate if the stock price starts to drag, as buying back shares at lower prices is a more efficient use of capital than buying at higher prices. That dynamic will make it much harder for dividend investors to find an attractive entry point, even if the stock's general situation is quite favorable for shareholders seeking growth rather than cash flow.
Over the last five years, Novo Nordisk's annual dividends per share rose by an average of 6.5% each year. That means it would take many years before its hikes would add up to be significant passive income, even if you invested a lot upfront. For instance, if you wanted to make a mere $1,000 in yearly passive income, it'd take an investment of more than $90,900. Most people don't have anything approaching that sum readily available to invest. And it's also such a large sum that it'd take a very long time to build up a position by dollar-cost averaging (DCA) with a small amount each month too.
For the sake of comparison, another popular stock for income investors, AbbVie, hiked its payout by an average of 17.6% annually over the last five years. It made those increases while facing down the prospect of collapsing profits due to the loss of exclusivity of its highest-earning medicine. Novo Nordisk's rate of dividend hiking, even now, during the sharpest period of its ascent, is simply nowhere near being notable.
So Novo Nordisk isn't a viable dividend income stock at the moment. While that situation could change in the future if management decides to radically change its strategy for capital allocation, it'd probably be more prudent to invest in this stock based on further growth opportunities anyway. It's a solid growth stock that also pays a dividend, so it still might be of interest for investors who don't need a high cash return on their investment.
