Forget T-bills, Buy These Pharma Dividend Stocks Instead

Even with yesterday's stock rally, the yield on a 10-year T-bill was less than 2.3% yesterday. I understand the whole flight-to-safety thing, but who the heck is buying those things? Pharma stocks offering dividend yields that are double the current interest rates on 10-year T-bills look like a much better risk-reward proposition.

But they're not guaranteed!
True enough. T-bills are backed by the full faith of the U.S. government, which despite what Standard & Poor's might say, is still as valuable as it gets. When you buy stocks, there's a risk that the share price will decrease.

But you're giving up an awful lot for that safety. As an experiment, I figured out how much pharmas would have to fall in order to break even with T-bills.

Source: Capital IQ (a division of Standard & Poor's) and author calculations.

That's an awful lot of protection to the downside. And it assumes dividends won't increase over the next 10 years, which is a fairly conservative assumption. Johnson & Johnson has raised dividends for the last 49 consecutive years.

The calculations also don't take into account reinvesting dividends, which would increase the potential returns even further compared with T-bills.

What about the patent cliff?
It's true, many pharmas will lose a substantial portion of their revenue when big drugs like Pfizer's Lipitor and Bristol and Sanofi's (NYSE: SNY) Plavix go off patent. As soon as cheap generics move in, sales head toward zero almost instantly. The sales decline sometimes even starts a few months early as pharmacies deplete their stocks, anticipating the arrival of the generics.

The thing is everyone knows the patent cliff is coming. There are no surprises here; the inevitable declines in revenue are priced in. Eli Lilly, for instance, trades at a P/E under 9. That's superficially crazy-cheap because everyone knows its earnings are going to drop over the next few years.

Getting paid to wait
If we're comparing investments in pharmas to 10-year T-bills, shouldn't we be looking at what pharma's value will be in 10 years? Even in the long drug development cycle, 10 years is plenty of time to turn things around. A decade from now, most of the early-stage drugs will have progressed through phase 3 testing and will be on the market if their efficacy and safety pan out.

If you have that long of a time frame, Eli Lilly might be a decent bet. There's little in the late-stage pipeline that will offset the near-term revenue decline, but the company does have a whopping 58 molecules in phase 1 and phase 2 development that could help increase revenues well after the patent cliff sets in.

For a more near-term investment, consider Bristol-Myers, which has had a string of solid approvals lately, including melanoma drug Yervoy and kidney transplant treatment Nulojix. The company is still guiding for post-Plavix 2013 earnings just a little lower than last year's level, but I think that might be boosted slightly when management gives its 2012 guidance later this year.

Looking for more options?
If you have a long-range forecast -- and why else would you be considering 10-year T-bills? -- you can likely make considerably more with dividend stocks with only a modest increase in risk.

To decrease that risk further, consider investing in divided stocks outside of the pharmaceutical industry as well. The Motley Fool's free report "13 High-Yielding Stocks to Buy Today" offers up additional suggestions. Pick up your copy by clicking here.