Buying stocks that pay dividends should be a cornerstone strategy of nearly every investor's portfolio. After all, who doesn't like opening up a brokerage account and seeing more cash on hand than the day before?
While dividend paying stocks can be found in nearly every sector, you probably don't immediately think of dividends when you think of investing in biotech stocks. However, I think that Gilead Sciences (NASDAQ:GILD) and Amgen (NASDAQ:AMGN) are two biotech blue chips that are certainly worthy of your consideration for the dividend portion of your portfolio, as both of these companies have stellar financials that should allow them to return cash to shareholders for years to come. But which of these stocks is the better buy today?
To answer that question, let's check up on a few dividend-related metrics for each of these stocks to see if we can find a winner.
Current dividend yield
Any conversation about a dividend-paying stock almost always begins with a look at the current dividend yield. In general, a higher current yield is more preferable to a lower one, as it allows investors to earn a higher immediate cash return on their investment.
Amgen is currently paying out $3.16 per share each year, which based on the current share price gives the company a current yield of 2%, which is slightly higher than the S&P 500's current yield of 1.96%. Gilead, on the other hand, is currently paying out $1.72 per share in dividends, which gives investors a yield around 1.5%.
Free cash flow payout ratio
The free cash flow payout ratio represents the percentage of a company's free cash flow, which is defined as cash from operations minus capital expenditures, that it uses to pay out the dividend. A lower payout ratio is more preferable to a larger one, as a lower ratio indicates that a company has more room to increase the dividend in the future.
Amgen will spend around $2.4 billion on dividends this year and generated $7.8 billion in free cash flow last year, giving it a very sustainable payout ratio of 30%. Gilead current dividend should cost about $2.5 billion per year, which when compared to the massive $12.3 billion of free cash flow it generated 2014 is very low 20% payout, which indicates it has plenty of room to further grow its dividend in the coming years.
Dividend history and growth
Investors seeking dividend stocks like to see a long history of steady dividends and in particular should be on the lookout for how the dividend performed during periods of market distress. We don't have a tremendous amount of data to go on here, as Amgen only started paying a dividend in 2011, and Gilead only started earlier this year.
While we don't have any history to look at to access Gilead's dividend growth, Amgen has grown its dividend quickly and has increased it every year, for total growth of more than 182%.
When it comes to evaluating the future returns a stock can offer, no analysis would be complete without talking about valuation. Since both of these companies are big and profitable, using the price-to-earnings ratio, or P/E, is a simple but effective way to gauge the current market valuation. In general, a lower valuation is preferable to a higher one.
At 23, Amgen has a trailing P/E ratio nearly twice as high as Gilead's, and much higher than the S&P 500's trailing ratio of 18. Gilead's P/E ratio of 12 is considerably below the markets, which is far more desirable.
Future growth prospects
Despite their huge size, both of these companies remain firmly in growth mode as they continue to roll out their numerous blockbuster drugs around the world and launch new drugs.
Amgen recently received approval for Repatha in Europe, which was the first of a new class of cholesterol lowering medications to be approved in the world, and could easily hold multi-billion dollar potential. The company recently raised its guidance for the year and is currently expecting to grow earnings by around 11% this year, which is a very respectable growth rate for a company of Amgen's size.
On the other hand Gilead growth has been jaw-dropping recently thanks in large part to the success of its Hepatitis C treatments Sovaldi and Harvoni. When you combine the success of these drugs with Gilead's dominant HIV franchise, Gilead's earnings grew almost 4-fold in 2014. When you add the continued rollout of Sovaldi and Harvoni into other countries like Japan and add in a massive share repurchase program, its no wonder analysts are predicting earnings growth of more than 20% over the coming five years.
And the winner is ...
Both companies appear to be great choices for investors looking to add a little yield to their portfolio, but if I could only pick one it would have to be Gilead. While the company has a lower yield and a shorter history of paying dividends, it sports a lower payout ratio and a better valuation and is predicted to grow earnings much faster over the long term. These factors make me believe that the total return to shareholders will be higher for Gilead over the coming years, making it my choice as the better dividend stock, and one that you should probably consider adding to your watchlist.
Brian Feroldi owns shares of Gilead Sciences. The Motley Fool recommends Gilead Sciences. The Motley Fool owns shares of Gilead Sciences. 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.