How to Pick the Best High-Yield Stocks in Big Pharma

by Jeff Reeves | August 8, 2012 6:15 am

Big pharma is a good sector to explore right now amid the dividend craze. Obviously, high-yield stocks are in favor as rates remain paltry elsewhere — 1.6% or so in 10-year Treasuries and 1.9% or so in five-year CDs as of this writing.

Of course, those dividends only matter if other troubles don’t erode share prices and leave you with a small quarterly payday but a big capital loss in shares.

Big Pharma stocks clearly have the yield. And in my opinion, they have the broader stability that makes them attractive as defensive investments. The health care sector is recession-proof[1] — since folks spend money on drugs and treatment no matter what the marcoeconomic picture is.

These Big Pharma stocks also have growth in their future thanks to demographic trends[2]. As the baby boomers age, the need for health care devices and services will only grow.

So the only question, then, is finding individual companies in Big Pharma that can overcome any patent issues and short-term troubles and cash in on these big long-term trends.

While delivering a high dividend, yield of course.

Here’s a list of the players (pharmaceutical stocks over $100 billion in market cap) and their current dividend yields:

A balanced portfolio needs only one or two of these stocks, so now our goal is to take the best from this list.

Five of these players actually have a negative growth rate in earnings over the past five years. The worst is Merck, with an 8% slide annually, while Sanofi is barely in the red with less than a 1% decline on average across the past five years.

The only two boasting a positive growth rate are Abbott and Pfizer. And frankly, I like both.

The Case for Abbott

Take Abbott, which might surpass Pfizer’s heart drug Lipitor with its Humira arthritis medication as the best-selling drug ever thanks to its later patent expiration of 2017. That ensures stability in the short term, and the cash to formulate a Plan B.

And in the meantime, Plan A is working fine. Abbott is riding 13 consecutive quarters of year-over-year revenue growth, and recently posted strong earnings and reaffirmed its outlook despite a stronger dollar creating headwinds[10]. Shares are up 17% year-to-date in 2012.

Abbott also is planning a unique $15 billion spin-off called AbbVie, which will become a new publicly traded stock and manage Abbott’s research-based pharmaceuticals business. The deal will close by the end of 2012. The icing on the cake is a 3.1% yield, which is the lowest of its peers but has been raised annually for 40 straight years[11]. That’s a reliable payday you can count on growing over time, not just paying out each quarter.

The forward P/E ratio of 12.3 is a bit higher than its peers, but still pretty affordable. After gains of 31% in the past 12 months, there is a small risk of buying a top, but ABT remains one of the best picks in Big Pharma.

The Case for Pfizer

Pfizer is equally attractive for long-term, low-risk investors seeking yield. Despite its stronger long-term growth rate, Pfizer has a forward P/E of about 10.3 now — the lowest of any pick on this list of Big Pharma stocks.

The charts also look good. InvestorPlace chief technical analyst Sam Collins recently pointed to a technical breakout in Pfizer back on July 17[12], and again on July 30[13]. That resulted in a new 52-week high for stocks, but since then shares have rolled back a bit and might present an entry point for new investors.

Of course, Pfizer has its challenges now that Lipitor is off patent. The company still is squeezing out bigger profits[14], but admittedly cost-cutting is fueling the growth. It’s also worth noting that some of the previous stability came from a shrewd 2009 acquisition of Wyeth that bolstered sales and operating margins. Without another big buyout, there is the risk of nothing else to step in and fill the void.

Then there are obvious pipeline risks and a lack of future money-makers. PFE admittedly has struggled to get a new major drug approved, but I like the track record of Pfizer, as well as its 3.7% yield.

The Other Pharma Stocks

To be clear, there isn’t a dramatic difference between these stocks, so you don’t have to jump based on my gut feeling alone. Do your own research and consider any one of these big pharma giants because of the long-term demographic trends supporting sales and the recession-proof nature of health care.

Merck could be a good turnaround play. Merck has the worst long-term performance of this group, as MRK stock languished in 2010 and 2011. The company even posted a quarterly loss thanks to charges relating to its Schering-Plough merger. But in the past two months, shares have soared almost 17% thanks to strong earnings and news that its experimental osteoporosis drug odanacatib[15] is faring well in studies. It also helps that gains from cost-cutting (including 13,000 layoffs[16]) are starting to take hold. There’s also emerging markets to look forward to, considering that in the latest quarter about 18% of MRK’s revenues came from these markets. If you can look past some of the bad headlines in 2010 and 2011, this stock might be up-and-coming in Big Pharma.

Johnson & Johnson also faces a colored history, including numerous safety and recall issues. But new CEO Alex Gorsky[17] is looking to return to this company’s roots with a focus on quality and the customer. With a big suite of consumer products that include Band-Aids and Tylenol, this could give JNJ an edge as a consumer staples play as much as a pharma company.

However you slice it, you probably should have one or two big pharma stocks in your portfolio if you’re a buy-and-hold dividend investor. The yields are nice, the sector is strong and demographic trends are in your favor.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[18] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.

Endnotes:
  1. The health care sector is recession-proof: http://investorplace.com/2012/07/5-health-care-mutual-funds-to-buy/
  2. thanks to demographic trends: http://investorplace.com/2012/07/7-long-term-demographic-trends-to-play/
  3. ABT: http://studio-5.financialcontent.com/investplace/quote?Symbol=ABT
  4. GSK: http://studio-5.financialcontent.com/investplace/quote?Symbol=GSK
  5. JNJ: http://studio-5.financialcontent.com/investplace/quote?Symbol=JNJ
  6. MRK: http://studio-5.financialcontent.com/investplace/quote?Symbol=MRK
  7. NVS: http://studio-5.financialcontent.com/investplace/quote?Symbol=NVS
  8. PFE: http://studio-5.financialcontent.com/investplace/quote?Symbol=PFE
  9. SNY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SNY
  10. despite a stronger dollar creating headwinds: http://www.reuters.com/article/2012/07/18/us-abbott-earnings-idUSBRE86H0JM20120718
  11. has been raised annually for 40 straight years: http://investorplace.com/dividend-paying-stocks/
  12. a technical breakout in Pfizer back on July 17: http://investorplace.com/2012/07/trade-of-the-day-pfizer-inc-nyse-pfe/
  13. again on July 30: http://investorplace.com/2012/07/trade-of-the-day-pfizer-nyse-pfe/
  14. squeezing out bigger profits: http://investorplace.com/2012/07/pfizer-tops-q3-earnings-estimates/
  15. experimental osteoporosis drug odanacatib: http://investorplace.com/2012/07/merck-could-have-a-homerun-in-sight/
  16. including 13,000 layoffs: http://www.rsc.org/chemistryworld/News/2011/August/03081102.asp
  17. new CEO Alex Gorsky: http://investorplace.com/2012/02/5-ways-alex-gorsky-can-heal-ailing-jj/
  18. “The Frugal Investor’s Guide to Finding Great Stocks.”: http://www.amazon.com/dp/B007KB9CSI/ref=rdr_kindle_ext_tmb

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