Dividend stocks tend to be strong performers over the long term due to their ability to harness the awesome power of compounding returns. Even so, investors should always bear in mind that not all dividend stocks are good investments, even when they are associated with a strong brand.
Many top healthcare names are offering historically high yields this year because their stocks have fallen in the face of the ongoing patent cliff. The general trend across the sector has been for companies to suspend share buybacks but to keep dividend payouts steady. As a result, the sector now boasts of multiple household names sporting yields that exceed 5%, including AstraZeneca (NYSE:AZN) and GlaxoSmithKline.
While these juicy yields might sound enticing for income-hungry investors, I think a deeper look at their growth prospects is critical before purchasing shares. For example, Pfizer (NYSE:PFE) today offers an attractive yield of 3.54%, and given its instant brand recognition, investors with a long-term outlook might find this stock to be a compelling buy.
Nevertheless, I think Pfizer is one dividend stock that should be avoided for now. Here's why.
Pfizer's growth prospects are murky at best
With the loss of patent protection for former top-selling drugs including Lipitor and Celebrex, Pfizer has turned primarily to its clinical pipeline to generate top-line growth. This strategy might prove correct, but it's not without potential pitfalls.
On the bright side, new iterations of the blockbuster vaccine Prevnar appear to be on track. And Pfizer's JAK inhibitor, Xeljanz, and its blood thinner Eliquis (co-developed with Bristol-Myers Squibb) should help to stem the tide of falling revenue moving forward.
Pfizer's problem in the clinic is uncertainty regarding its ability to generate new blockbuster drugs. The company decided, along with almost every other Big Pharma simultaneously, to go after novel oncology and high cholesterol drugs to replace former stars.
On the oncology front, Pfizer is developing its CDK4/6 inhibitor, palbociclib, for advanced breast cancer. Although this indication has megablockbuster potential, the market might be flooded with new CDK4/6 inhibitors in the next few years -- Eli Lilly and Novartis are aggressively pushing their competing drugs toward regulatory filings in an attempt to catch up with palbociclib.
Turning to the high cholesterol arena, Pfizer has joined the PCSK9 inhibitor race with bococizumab. Experts predict this new class of cholesterol treatment could generate sales in the multiple of billions.
That being said, the market already looks close to the saturation point with Amgen (NASDAQ:AMGN) and Sanofi (NYSE:SNY)/Regeneron (NASDAQ:REGN) pushing their own PCSK9 inhibitors toward regulatory approval. Simply put, we could see three different PCSK9 inhibitors gain approval next year, all within months of one another.
Pfizer needs to reorganize or execute a tax inversion to unlock value
Over the next five years, Pfizer is projected to average only a tad over 3% growth in terms of earnings per share. In an industry in which double-digit growth is becoming commonplace, Pfizer is being left behind, making it little wonder why the company's share price has underperformed this year.
The company's growth problems haven't escaped management's collective attention -- not by a long shot.
To reignite Pfizer's growth prospects, the company aggressively pursued a merger with AstraZeneca earlier this year and is reportedly looking into additional deals that would lower its 27.9% effective tax rate into the low teens.
Management has also openly floated the idea of a massive restructuring that would break the company into three units, which would unlock latent value in high-growth areas. In short, management believes that top-line growth is being diluted by Pfizer legacy products that have lost patent protection, and this is one way to separate the proverbial wheat from the chaff.
While Pfizer still has a strong cash flow that should allow it to keep the yield stable moving forward, the company is in the midst of a major transformation in which the outcome is highly uncertain. Staying put and relying on new products to generate growth looks problematic for the reasons outlined above. Pfizer also doesn't look like it will be able to push through a merger with AstraZeneca to lower its effective tax rate and gain access to a robust clinical pipeline at the same time.
That leaves the restructuring option, which has popped up numerous times in the past two years without coming to fruition. The problem is it's wholly unclear how a spin-off, or a sell-off of legacy products, would affect current investors down the road.
Given that the sector has several other options for high yields, I think income investors should pass on Pfizer until these uncertainties are resolved.
George Budwell has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.