When it comes to crafting the perfect retirement portfolio, I'd be remiss if I played down the critical role that dividends have in supplementing retirees' incomes and providing compounding gains over time for preretirees.
Why dividends are so important
Some of the world's wealthiest investors, such as Warren Buffett, have grown their wealth with great success in recent decades by relying on high-yield dividend stocks to fuel their portfolio. Dividend-paying stocks provide a number of advantages that their nondividend-paying counterparts simply don't.
For example, dividend stocks are profitable (otherwise they wouldn't pay a dividend), so you could certainly say that a dividend acts as a beacon for income-seeking investors that says, "Look, my business model is sustainable!" In addition, dividends provide a nice downside buffer in case the U.S. economy goes into a recession. Remember, recessions are a normal part of the economic cycle, and dividend payments can help an investor weather unexpected movements to the downside.
Obviously, the higher the yield, the better it is for the investor -- but this notion comes with quite a few asterisks. High-yield dividend stocks are attractive from an income standpoint, but we have to fully understand the nature of the business behind the dividend to see if the business model is sustainable or in trouble, or if the dividend itself is primed to be cut. In a perfect world, when looking for quality high-yield dividend stocks we want a nice balance of growth, value, and sustainability for the company as a whole and its dividend.
Danger lurking in the healthcare sector
Among the stock markets' various sectors, healthcare is among the weakest when it comes to the number of high-yield dividend stocks. The reasoning is pretty simple: Healthcare is a capital-intensive industry that requires a lot of money upfront to pay for research and development costs for drugs and medical devices. Since the drug development or device development pipeline means everything to these companies, it often pays for them to reinvest in their business rather than kick out a 3% or higher dividend yield to investors.
Of course, there are some very nice dividends within the healthcare industry, too. GlaxoSmithKline, for instance, is a giant pharmaceutical company paying out around 5.5%, which looks sustainable considering its large and diversified product portfolio and development pipeline.
Then again, some of the highest-yielding stocks wind up being the biggest traps for investors. Within the healthcare industry the highest-yielding dividend stock is PDL BioPharma (NASDAQ:PDLI) with a current yield of 7.5%. Though this high-yield, if paid consistently, could double your initial investment in less than 10 years (or even quicker if the payout were reinvested in the stock), PDL BioPharma's dividend has "danger" written all over it.
The high-yield dividend worth avoiding
On the surface PDL BioPharma actually looks like a well-oiled machine. Unlike your typical biotech firm that puts millions, or billions, of dollars into research and development in order to create the next great treatment for varying diseases and disorders, PDL collects royalty payments on its antibody humanization patents or purchases a percentage of the licensing rights to certain drugs. It's one of a very select few royalty rights companies in the healthcare industry.
On one hand, PDL benefits from an incredibly low cost structure, which tends to lead to healthy profits. In its third-quarter earnings report, released just last week, the company announced a huge 64% surge in revenue to $164.6 million as its profit leaped to $102.2 million, or $0.61 per share, from $56.2 million, or $0.36 per share in the prior-year period. With little need for a large staff, PDL's primary focus is on generating cash to acquire new assets.
The royalty and licensing business model works wonders in most industries, but it's a dangerous game to pay in the healthcare arena because of the finite patent exclusivity period of innovative drugs. The Food and Drug Administration allows patents to remain in place for a period of 20 years, and the clock starts ticking when biopharmaceutical companies begin human clinical testing. In other words, most patents, by the time a drug reaches pharmacy shelves, are really only in place for about a decade. This means PDL needs to replace its revenue stream on a regular basis, otherwise its business model may not generate enough cash to make the venture worthwhile.
The key drugs currently providing PDL BioPharma with a good chunk of its revenue and income include Avastin, Herceptin, Xolair, Kadcyla, Perjeta, Tysabri, and Actemra, to name a few.
Some of these therapies have a long shelf life still to come, including Roche's (OTC:RHHBY) Perjeta and Kadcyla (Kadcyla was co-developed with ImmunoGen). However, other important drugs that PDL currently receives royalty revenue will be nearing their patent expiration period sooner than later, such as Biogen Idec's (NASDAQ:BIIB) Tysabri. Replacing lost revenue from exclusivity losses is a cost-intensive project for PDL, and it ultimately could result on the company issuing more shares to cover those costs and diluting investors, or simply winding down its business if it can't replace enough of the royalty revenue lost.
This unpredictability of its business model and the fact that it has no control over the sales success or production of the therapies it's receiving royalty rights from makes PDL BioPharma a very risky high-yield dividend stock, and one that you'd probably be best off avoiding altogether.