Healthcare's Greatest Dividend Stocks

Ever wonder why certain healthcare stocks are yielding such high dividends? On this Industry Focus, Motley Fool analyst Kristine Harjes and contributor Todd Campbell break it down in terms of what makes a good high-dividend stock, how to do the background research on the stock, and what flags to watch for.

For our best dividend stock ideas from the cast of Industry Focus, check out dividends.fool.com. A full transcript of this episode follows the video.

Kristine Harjes: Dividend hunting in the world of healthcare... this is Industry Focus. Hi, everyone. Welcome to Industry Focus healthcare edition. I'm Kristine Harjes and I'm joined via Skype by Todd Campbell. Todd, how are you?

Todd Campbell: I'm doing great this week.

Harjes: Great, good to hear. So it is dividends week on Industry Focus as our listeners who have been with us so far this week will know. And so we wanted to just take a dive into the world of dividend investing.

I mean it's something that is really, really important for retirement portfolios and people that are looking for steady income. But it's important for all portfolios. I mean, they're a hallmark. Dividend stocks over time will bring you into some really great returns.

But there's so many dividend-paying companies out there. How do you know which ones to buy? And so we wanted to split it up by industry and have everybody on the show just take a look into dividends within their sector, the questions that are unique to the space, and what are some promising companies to look at.

So, of course, the first number that you're going to look at when you turn to dividends is the yield. How much is this company paying you? And to me, the first question that that raises, and I want us to answer it through kind of a healthcare lens but also in general. Todd, is a bigger yield always better?

Campbell: First, I'm so happy we're talking about this because I think this subject is very important. People are relying more and more on dividend-paying stocks to boost their portfolios to generate retirement income, so it's great that we're having this open discussion on dividend-paying stocks and things to look for.

As far as high-yield stocks, no, not all dividend-paying companies are created equal. And I think investors need to take a very careful look especially in the healthcare arena at high-dividend-paying stocks to see why shareholders may have sold down the shares in these stocks, and that's what's responsible for the increase in yield. Because remember the yield is going to be a reflection not only of the share price direction but also the payout. So those two things can cause...

Harjes: Yeah, of course, if you have a percentage, it's going to be a fraction. So you can have a really high fraction because the numerator's really big or it could reflect the denominator. So the two aspects to look at there. So if it's because the stock's price has been hammered down, then that's certainly not a good sign.

Campbell: Right, and if you get a very high-yielding stock like in healthcare, there's this company called PDL BioPharma (PDLI) that yields very high. And people will look at that and say, "Oh my God, that's a great dividend. It's north of 10%. I've got to own that." Problem is the stock has been cut in half in the past year because a lot of royalties that they're earning are the contracts that they have that are paying out those royalties are ending.

So, yes, you have to do your due diligence to make sure that if there's a high dividend yield, that there's no other reason why that dividend yield is high other than the stock is on sale.

Harjes: Yeah, I think it's always something to look out for when you see a yield that looks too good to be true. It could be fantastic, but for me, I would say it's about a yellow flag. If I see something that's greater than the average. I mean the S&P 500 yields about a 2% dividend payment. So if I see more than that, it's definitely worth investigating.

And maybe not a definite flag that you need to stay away, but certainly worth trying to figure out: Is the yield high due to share price declining or is it some management gimmick to keep investors interested in some otherwise uninspiring stock? There are questions to ask when you see something that's really high.

But, in general, if you look at a stock and it's got a solid dividend payment and you dig in a little bit, what you want to be looking for is this stable promising future. I mean that's really what it comes down to is a stock that's going to continue to pay a high dividend, needs to be able to find the money to pay it somewhere.

So how exactly would you go about figuring out, "Am I going to continue receiving these dividend payments? Is my investment safe?"

Campbell: I always look at three things when it comes to healthcare stocks. I look at the products they have on the market currently, I look at the pipeline of drugs that are coming up through the ranks, and I look at their financial condition to make sure that they are rock-solid and continue to make those payments.

So, to your point, yes, you want companies that are growing, not shrinking. You don't want to buy Polaroid or RadioShack because they have a dividend yield and their businesses aren't growing. So make sure that you're looking for companies where the products that they currently market, the sales are growing, make sure that their pipelines are filled with drugs that could be good top sellers and can offset the patent risk that exists in this industry. And then make sure that their balance sheet looks good.

Patent risk is huge right now in healthcare. It's clobbering a lot of the industry giants and it's making a lot of these yields look super attractive. For example, you take your GlaxoSmithKline (GSK 0.12%), for example. They've got a 5.84% yield, which is super high for healthcare, but they're wrestling these patent woes. And I'm not sure if they're going to be able to replace the declining respiratory portfolio.

Campbell: They've launched some new drugs that they were hoping would take market share away from their Advair Diskus, which is a massively important drug to this company... selling a $4.8 billion annualized run rate, which is about 20% I think of Glaxo's total revenue. And the patent on Diskus, the inhaler device, that expires next year. So who knows when generic competition is going to enter and start eating away at that market share. But it's certainly one of those, we'll call them yellow flags again, where we're talking about, "OK, we've got a high dividend yield, why?" And in this case, it's because they're losing patent protection on a very important drug.

Harjes: For me, I don't really see a lot of promise for a dividend investor looking at GlaxoSmithKline. But, on the other hand, I think one particularly promising company in the healthcare space only pays out a 2.09% yield. That company is Amgen (AMGN -1.33%). But their future to me looks promising enough. Would you agree, Todd?

Campbell: Amgen's an interesting stock. You can look at this company and say, "Wow, this is a pioneer because it was one of the first biotech companies to launch and roll out biologic drugs, generate lots of revenue, so much revenue that they were kicking out extra cash that they could then return in the form of dividends." Typically, in healthcare you're talking about a dividend-paying structure -- typically pharmaceutical companies or medical device companies -- not biotechnology stocks like Amgen.

So, you could look at that say, "Wow, Amgen's got one of the longest track records in biotech are paying out money back to shareholders via the dividend." What's this business look like? You could argue that it looks really good because they're working on a ton of new products including Repatha, which was recently approved for the treatment of high cholesterol levels and that could be a billion-dollar drug.

They've also got nine different drugs in trials that could be generic alternatives of top-selling medications, called biosimilars. Those biosimilars could be coming in the market the next few years and generate billions of dollars of revenue for the company that way as well. But there are also some risks with Amgen -- namely, biosimilars that are being developed at other companies that would challenge Amgen's drugs.

For example, this past year Novartis won approval for an alternative to Amgen's Neupogen. And recently, last week I believe, Sandoz, which is Novartis' generic unit filed for approval of a biosimilar to Neulasta. Now those two drugs have a $5 billion a year run rate and Amgen has $20 billion in sales. So this is one situation where I feel like they've got enough in their pipelines for this not to be a problem. But there are some risks that are associated with it as well.

The last comment I would just make on Amgen is, and this is an important thing to consider, I always look at something called the cash dividend payout ratio. Now what this does is it says, "OK, rather than looking at earnings, which accountants can game a bit. Let's look at the cash flow that is being generated by the business and then see what percentage of that is being paid back to investors in the form of dividends."

If it's a high like a 1, that's bad. At Amgen, it's not worrisome; it's not a high number where I think we're going to be OK there.

Harjes: It comes in right around 26%, which means there should be plenty of room to continue growing the dividend, or if earnings were to shrink, if biosimilar competition is more of a threat than currently it seems like it would be, there still should be a little bit of a buffer zone for the business itself.

You made a really interesting point earlier about it being kind of rare to find dividend-paying biotechs. Recently, by recently I mean February, so sort of recently, Gilead Sciences (GILD -2.70%) started paying out a dividend and it never had before done that. It was a small dividend. I think right now the yield is around 1 1/2%, but it's kept a steady payout since then and it has raised this interesting question to me of do we want to see biotechs paying out a dividend in the first place?

As investors, it's great to get a check in the mail especially if you're going to reinvest the dividends. But for a biotech company where so much of the company's worth has to do with the pipeline and the research and development spending. Don't we want to see all of their cash going straight back into R&D?

Campbell: This is an ongoing debate in the industry. And investors really have come down on both sides of the fence here. If you're paying a dividend like Gilead decided to do, in theory you open up the investor base to, let's call them more steady hands.

People who are dividend investors typically are not looking to trade in and out of stocks. OK? They're looking to make long-term investments and that means that you've got less volatility in the share price, which means that you have more insight into your ability to raise money in the open markets that can be then used to help develop new medicines.

So, on the one hand, yes, dividend payments take away money from R&D, right? Because obviously if you're spending that money back to investors, you're not plowing it back into your own drug development, right? But at the same time, it also creates a more desirable shareholder base that over time can be more consistent.

Harjes: That's a really good point. I mean dividends are a long-term kind of game. I mean you're not going to hop in and out on a daily basis of dividend stocks. That's just not how this all works.

Speaking of long term, I ran some numbers earlier today on my favorite healthcare dividend company, and if you had invested $10,000 in this company at the beginning of 1985, it would be worth today -- and this number really does baffle me -- it would be worth today $461,216 without dividends reinvested. Now if you had taken those dividends and reinvested them, you'd be sitting on $718,367. So that's the difference in $461,000 versus $718,000.

Now I'm not going to share what that company is on the show. Because I really would love to encourage everybody to check out on our website -- the folks that you hear every day on Industry Focus put together a roundtable article in which we each pitch our favorite dividend stocks from the sectors in which we specialize. You can see this article totally for free at dividends.fool.com.

Definitely check it out. There's some really awesome content on there. You can learn what this company is you can also find out some of our other favorite dividend stocks in all the sectors that you hear covered on the show.

With that, probably a good time to remind everybody that Todd and I, people on our program, we might have interests in the stocks that we talk about. The Motley Fool could have formal recommendations for or against them, so do your research. Dividends.fool.com is a great place to start if you're looking for some great dividend ideas.

I want to end the show with something kind of Foolish that a listener sent in. But before we move on, I just want to go back to you, Todd, and see do you have any final thoughts for our listeners as they're looking through and trying to craft a dividend portfolio?

Campbell: Quality, quality, quality. Don't reach for yield. I mean historically over time when interest rates have started to rise, dividend-paying stocks have not performed quite as good as they do when interest rates are falling. So make sure that as you're planning your portfolio that you're focusing on the highest-quality companies and you're not chasing yield.

Harjes: That's great advice. So moving on to a listener...  it's comments, I guess. It's not quite a question. But a listener sent in an email to [email protected] where you can always contact us. And I thought it was absolutely worth sharing. So thank you to Fred Gattis of St. Louis Missouri who saw this and thought, "What a Foolish CEO."

So yesterday Radius Health (RDUS 1.28%) announced a delay in the submission of a new drug application to the FDA for an osteoporosis drug. The target for this NDA had been the end of 2015 and they announced that they're going to delay it to the first three months of 2016; which investors do not react well to this news.

But if you actually dig in and you listen to what he has to say, CEO Robert Ward who actually came from AstraZeneca, he says, "Part of our assessment was, is this the time to ask everyone in our supply chain to work on an accelerated basis over a period of time when they all had personal plans? Or was it better for us to pick a timeline that was more respectful for what the overall work-life balance might be across our whole supply chain?" He goes on to say, "When we think about the agency today, we want a chance to dot every i and cross every t and take our time. It's the holistic element, right? So it's individuals in the company who just completed a huge milestone of submitting our MAA. Did we really want ask them to skip Thanksgiving and Christmas this year?"

How cool is that?

Campbell: Very cool, very cool. You know, this is an interesting company because they're doing some fantastic things in developing new therapies for osteoporosis, a very important condition. They've already filed, they raced to file in Europe and that's now done with, and you're still going to see this filing occur early next year. So it's not like this is going to radically change their business plans. And I think that this just shows you that there's a human element that's involved in all businesses that shouldn't be ignored.

Harjes: Absolutely and especially when you're in the business of healthcare, there's the human element of you being the worker who's developing these drugs, and then there's the human element of the product being able to change lives with your work and have that fulfillment. And on that warm and cheery note, we'll sign off for now. Thanks for listening!