While GlaxoSmithKline plc (NYSE: GSK) is more than twice as large as AstraZeneca plc (NYSE: AZN), the two pharmaceutical companies have a lot in common. Both are based in the United Kingdom. Both stocks have performed worse than the overall market during pretty much any recent time frame you want to pick. And both GlaxoSmithKline and AstraZeneca boast very high, nearly identical dividend yields -- Glaxo with a 5.7% yield and AstraZeneca with 5.8%.
But is one of these two British drugmakers the better dividend stock? Yes, although it's a close call. Here's why.
A stock's dividend yield provides only a snapshot. Investors seeking the best dividend stocks need to understand the track records over time. When it comes to historical dividend performance, AstraZeneca appears to come out on top.
For most of the past 20 years, AstraZeneca's dividend grew at a faster rate than Glaxo's. AstraZeneca's dividend also looks more attractive from a volatility perspective: in 2002, Glaxo slashed its dividend drastically. It took six years for the company's dividend to regain its previous level. AstraZeneca also cut its dividend early in the last decade, but the percentage decrease was relatively small.
Near term sustainability
The past is the past, though. What's more important is whether or not a company can keep its dividend payments flowing. On this question, GlaxoSmithKline definitely appears to have an advantage over AstraZeneca.
Glaxo's dividend payout ratio, which is the percentage of earnings that the company pays out in dividends, currently stands at 41%. That's an appealing figure, because the implication is that Glaxo shouldn't have near-term problems continuing to pay dividends at the current rate, and should still have money left over to invest in the business.
AstraZeneca, on the other hand, has a payout ratio of 300. In other words, the pharmaceutical company is currently paying out three times as much in dividends as it made in net income. Can this trend continue indefinitely? Nope. Something has to change -- either AstraZeneca's earnings climb dramatically, or its dividend will inevitably be reduced.
Long term prospects
Payout ratios are also snapshots in time, though. Earnings can improve tremendously or fall like a brick, greatly impacting the ability of a company to pay dividends. The best dividend stocks are simply the best businesses with the best long term earnings prospects. Unfortunately, both GlaxoSmithKline and AstraZeneca appear to have trouble on the horizon.
Glaxo's blockbuster respiratory drug Advair pulled in over $6 billion last year, even though it lost patent exclusivity several years ago. However, that revenue might soon be in jeopardy: biosimilars could hit the market in 2016. That's not the only challenge that the drugmaker faces. Some of its newer drugs, particularly respiratory drug Breo Ellipta, haven't performed as well as hoped. With competition likely on the way for Advair, Glaxo needs revenue from its more recent drugs to pick up, as well as some home runs from its pipeline.
AstraZeneca's outlook is also pretty gloomy. The company plunged off the patent cliff with loss of exclusivity for antipsychotic drug Seroquel and acid reflux drug Nexium. To make matters worse, AstraZeneca loses patent protection for big-selling cholesterol drug Crestor next year. While the company has some promising new drugs, including blood-thinner Brilinta and diabetes drug Onglyza, as well as plenty of future growth drivers in their pipeline, this won't be enough to offset the revenue lost due to patents expiring anytime soon.
The somber truth is that the dividends of both GlaxoSmithKline and AstraZeneca could take a hit in the future. Of the two, Glaxo gets the nod as the better dividend stock primarily because of its lower payout ratio. Although this ratio seems quite likely to worsen within the next couple of years as rivals for Advair enter the market, Glaxo has at least a little time on its side.
While Glaxo might be the better pick over AstraZeneca, investors looking for strong dividend stocks should probably search elsewhere. The chances that both of these British drugmakers cut their dividend payments down the road appear to be relatively high. A better bet doesn't always translate to the best bet.
Keith Speights 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.