With interest rates still sitting near record lows, looking for current income have been forced to move away from fixed-income positions and into stocks to find yield. To help offset those risks, one of the first things dividend investors do is look for companies operating in stable, growing industries, like Novartis (NYSE: NVS). But before doing the foolish thing and taking this dividend for granted, let's take a closer look at whether it's truly worthy of a spot in your portfolio.
Health is priceless; health care isn't
As a pharmaceutical company, Novartis benefits from many of the unique elements of the industry that make it attractive for dividend investors. We all know it's impossible to put a price on one's health and well-being. Because of that, and due to the unbearable cost of emergency health problems, insurance companies and government entitlement programs have taken over as the gatekeepers of health-care spending around the world.
But, the industry's high costs didn't just appear out of thin air. Partly to blame is the fact that our insurance systems have effectively masked the direct costs of health care by turning the system into a kind of all-you-can-eat buffet, removing most of the consumer-driven pricing mechanisms that exist in practically every other industry. This dynamic, along with the aging and increasingly unhealthy society that we're all well aware of, is a key reason why health-care spending will continue to grow.
While these big-picture trends might be driving the overall industry, investors looking at specific health-care dividend stocks need to dig a layer deeper to understand the company-specific issues at work. After all, dividends aren't a guarantee and, if the going gets tough enough, even a "stable" health-care stock could cut -- or eliminate -- its dividend. With that being said, let's check on where Novartis' dividend has been, and try to determine where it's going.
A quick-and-dirty technique for checking a dividend's sustainability is taking a look at something called the payout ratio. Typically, this is expressed as a percentage, looking at a company's dividend per share relative to its net income per share. That's a decent start, but I prefer to use a slightly different measurement that replaces net income, an accounting measurement, with something more tangible -- cold hard cash. The chart below shows how much of Novartis' free cash flow has been eaten up by its dividend payments over the past two years. The lower the better, suggesting more capacity for future dividend hikes.
Not all dividends are created equal. At first glance, a high dividend yield may look nice, but all too often, it means that a problem is lurking around the corner for a business. Looking at Novartis' 3.5% dividend yield in isolation only tells half of the story, which is why investors need to have an understanding of how the market perceives a company prior to buying a stock. We can do this by comparing a few financial multiples, like price to earnings, to its peers in the industry.
Up to this point, we've looked at Novartis' dividend in the past, and we've also seen how its stock is being perceived by the market today. However, the most important factor to consider when understanding a dividend's future is where the company's cash flow is heading. It's hard to generate more cash without growing sales, so let's take a look at what industry analysts are expecting for Novartis' revenue growth relative to peers this year.
Foolish bottom line
As you can see from the chart above, the loss of patent protection for hypertension drug Diovan is weighing on Novartis' revenue growth in the near term. In terms of valuation, the stock is a little on the pricey side for its relatively low growth profile, but arguably deserves a premium for a more diversified, defensible business model (branded and generic drugs, vaccines, consumer products) than its pure-play branded pharmaceutical peers.
Novartis deserves a serious look for income investors searching for a defensive dividend stock. And while this dividend might not be able to soar, long term investors can expect this payout to expand at a steady pace once the company's cash flow starts growing again.