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Every investor should consider dedicating a portion of his or her portfolio to dividend-paying stocks, as companies that consistently put cash back into shareholders' pockets tend to be great performers over long periods of time. While investors can find companies that offer dividend payments in nearly every sector of the stock market, the healthcare sector is an especially good hunting ground to find dividend payers.
Two companies that currently offer their investors big dividend checks right now are pharma giants Eli Lilly (LLY +2.56%) and Johnson & Johnson (JNJ +0.16%). Both of these companies produce billions in revenue and have been putting cash in their investors' pockets for decades. But which of these two stocks is the better buy today?
To answer that question, let's compare a few dividend-related metrics to see if they can help us pick the winner.
Current dividend yield
Lets get the ball rolling with the most obvious dividend-related metric by comparing the dividend yields these two giants offer. All else being equal, investors should prefer to invest in a company that offers a higher yield than a lower one.
Eli Lilly is currently paying out $2.00 per share each year, for a current yield of 2.56%, comfortably ahead of the S&P 500's 1.99%. However, Johnson & Johnson is paying out $3.00 per share each year, which gives it a super-sized yield of 3.31%, putting it far ahead of both the S&P 500 and Eli Lilly.
Advantage: Johnson & Johnson.
Free cash flow payout ratio
The free cash flow payout ratio represents the percentage of a company's free cash flow that it uses to pay out the dividend. In general, the lower payout ratio, the better, as it means that the company likely has more room to increase its dividend in the future.
Eli Lilly spent $2.1 billion on dividends over the past 12 months on dividends and generated only $2.3 billion in free cash over that same time period, which gives it a payout ratio of 91%. That's quite high. Johnson & Johnson, on the other hand, managed to shell out about $8 billion on dividend payments over the past 12 months, but it generated roughly $14.9 billion in free cash flow during the period, which gives it a much healthier payout ratio of 53%.
Advantage: Johnson & Johnson.
Dividend history and growth
Investors seeking dividend stocks should want to see a long history of consistent dividend payments and hence should take comfort that both of these companies have been paying dividends for decades. However, while steady dividends are great, what investors really want to see is a dividend that grows over time, as that's what really provides shareholders with a strong return.
Over the past five years, Eli Lilly has upped its payment by an anemic 0.17% annually, which makes sense given the revenue challenges this company has faced over the past few years. Johnson & Johnson investors have fared much better over that same period, as they've been treated to a dividend that's grown by a respectable, but not stellar, 6.58% over that time. Not to mention, J&J has increased its dividend payout for a remarkable 53 straight years!
Advantage: Johnson & Johnson.
Valuation
When it comes to evaluating the future return, no analysis would be complete without considering the company's current market valuation. We can do just that by using the price-to-earnings ratio, or P/E, as a rough metric to access the market's valuation of these companies.
At 36, Eli Lilly is sporting a trailing P/E ratio that's quite a bit higher than the S&P 500's current P/E of 22, which could indicate that the company is over-valued today. By contrast, Johnson & Johnson's trailing P/E ratio of 19 look quite reasonable and could indicate that there is upside to be had.
Advantage: Johnson & Johnson.
Future growth prospects
Of course, while all the numbers we've looked at so far are backward looking, what matters a great deal to investors who get in today is the future growth prospects of both of these companies.
Analysts are expecting that Eli Lilly will be able to grow its bottom line by an impressive 13% over the coming five years, which, if true, would certainly be welcome relief to its investors, who have had to deal with a nearly 8% decline in earnings over the past five years. On the other hand, Johnson & Johnson is only expected to grow at a far more modest 5% over the coming half-decade, which is less than half the rate expected of Eli Lilly.
Advantage: Eli Lilly.
And the winner is...
While both of these companies might be good choices for dividend-focused investors, if forced to choose between these two right now I would rather put my money on Johnson & Johnson. While it might not be able to match Eli Lilly's earnings growth over the coming five years, it's currently offering investors a higher yield, lower payout ratio, and better market valuation, which I think more than makes up for its lower growth rate.
