Pfizer (NYSE:PFE) announced this week that it has decided to increase its quarterly dividend -- by 26%! -- to $0.24. A double-digit rise like that is ecstatic news, of course, since dividends play such an important role in an investment's total return over its lifetime. And since free cash flow is the key to these kinds of increases, let's have a look at how the drugmaker rates on this count.

First, we'll peek at the company's annual report. I want to see how much net cash from operations Pfizer has generated over the past few years, the amount of capital purchases it has made, and the quantity of dividends it has paid out to shareholders. I want to see whether Pfizer's free cash flow is more than adequate to take care of the payment.

Here's how the numbers stack up, according to Pfizer's annual report for 2004. Remember, free cash flow is the deduction of capital expenditures (costs for property, plant, and equipment) from the net cash provided by continuing operations.




Cash From Continuing Operations




Capital Expenditures

$ 2.6

$ 2.6


Free Cash Flow


$ 9.1


Dividends Paid

$ 5.1

$ 4.4


($ in billions)

The dollar amount of dividends paid exists in a very comfortable ratio to free cash flow. Pfizer could actually double the number of dividends paid in each year and not use up all of its free cash. It wouldn't necessarily want to, of course, since free cash can be used for other purposes, such as buying back company shares, which the company has been doing for a number of years.

According to the latest 10-Q to see how free cash is faring at the moment, Pfizer reports that free cash flow was $8.5 billion for the past nine months. This represents a slight decrease from the $8.8 billion in the comparable period one year ago, but it's certainly nothing to panic about. Pfizer has approximately 7.4 billion diluted shares outstanding, so an annual payment of $0.96 per share would come out to $7.1 billion. And the company states that it expects to adjust working capital requirements and restructure its worldwide operations to keep cash flow strong.

Taking all of this data into account, I believe that Pfizer represents a good long-term dividend play. (I should note though, that in this sector, my inclination is more toward Johnson & Johnson (NYSE:JNJ) as an investing idea).

The pharmaceutical segment is not without risk, of course, given that blockbuster drugs are prone to competition as well as expensive and damaging litigation. Merck (NYSE:MRK) certainly has seen its share of such problems with Vioxx; Pfizer itself has had a challenging time with its Celebrex product. Plus, Fools should know that Pfizer's current woes are definitely not going to be solved quickly. But keep in mind that Pfizer continually invests in R&D, looking for that next superstar drug. Investors willing to hold for years while reinvesting dividends will most likely be rewarded along the way.

Some related reading:

Pfizer is a Motley Fool Inside Value recommendation. Merck is a Motley Fool Income Investor pick.

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Fool contributor Steven Mallas owns none of the companies mentioned. The Fool has a disclosure policy.