Pfizer (NYSE:PFE) stock is an attractive value play for 2020. PFE has a dividend yield of 3.8%, twice the S&P 500’s 1.8% yield.
In addition, the forward price-earnings ratio of Pfizer stock is only 13.2. That is significantly below the average P/E ratio of the S&P 500. So Pfizer, a huge brand-name drug stock, offers good value for investors.
Why Is Pfizer Stock So Cheap?
In late July 2019, Pfizer announced that it would spin off its off-patent branded drugs subsidiary, UpJohn, to the owners of Pfizer stock. The newly spun-off company will be merged with Mylan (NASDAQ:MYL), a generic drug company.
The move will take Pfizer’s highly successful branded drugs like Lipitor, Viagra, Zoloft, and Xanax and merge them with Mylan’s blockbusters like EpiPen.
But more importantly, the announcement of the spin off probably shocked investors. The owners of Pfizer stock had grown to love the power of its branded drugs, even though many of the treatments in the UpJohn subsidiary were off-patent.
Pfizer Confused Investors
And to be fair, most investors do not understand what a spin off is all about. They are used to owning the shares of one company with a regular dividend. Now they will have two companies which both will pay dividends.
Moreover, Pfizer stock will immediately drop once the spin off goes into effect. That’s because Pfizer is surrendering assets to another company. while the dividend of Pfizer stock will probably drop.
Moreover, in order to make the deal tax-free, it was officially called a Reverse Morris Trust combination. Pfizer shareholders will own 57% of the new company. The deal is expected to close in mid-2020. All of this was probably confusing to investors.
Pfizer stock fell over 22% in Q3 from its highs to its bottom. Since then, Pfizer stock has started to recover, as investors have begun to understand the benefits of the deal. But PFE is still cheap.
To pacify investors, the newly spun-off company, which has not yet been named, will pay a dividend. Pfizer said that the spun-off company will distribute 25% of its free cash flow to shareholders in the form of dividends each quarter.
More Pfizer Spinoffs
Pfizer contributed brands like Advil, Centrum, Robitussin, and ThermaCare. The combined company will be the world’s largest OTC consumer healthcare products company.
Pfizer now owns 32% of the JV. But when the deal closed in July, Pfizer announced that the JV would be spun off to shareholders of both PFE and GSK. In this case, GSK will decide the timing of the spin off, and it has five years to determine when it will occur. No matter what, though, the stock of the JV will be listed in the U.K.
So, again, shareholders were left wondering what they really will own. In this case, they won’t know for awhile how many shares they will get, and when those shares will be listed.
And, of course, shareholders hate uncertainty. They’re wondering how these spun-off stocks will perform and whether they will be better off owning three different stocks with different dividends.
Pfizer’s Previous Spinoff Was Successful
ZTE stock started trading at $31.01 when it was spun off in 2013. Now it trades at $139 per share.
That represents a gain of over 340% for Pfizer shareholders in six years. Moreover, that is an average compound gain of 28% per year.
Pfizer stock has risen only 43% during that same period. That represents an average annual gain of just 6%. But Pfizer has also paid a dividend during that time. So Pfizer stock has generated a total return of about 8% to 9% per year.
Therefore, assuming the owners of Pfizer stock retained all the shares of both companies, they received a great return. So distributing the unit to shareholders made sense, since doing so produced a higher return on investment.
Of course, the key to this ROI was patience. Shareholders had to patiently hold both stocks.
Pfizer Stock Is Cheap Relative to Its Peers
PFE is now cheaper than its drug stock peers. For example, PFE trades at a forward price-earnings ratio of 14 and has a 3.9% dividend yield. Its peers’ metrics are less attractive.
For example, Merck (NYSE:MRK) stock trades at 16 times forward earnings. MRK stock also has a lower dividend yield of just 2.7%.
So the owners of Pfizer stock are getting a great deal. Moreover, its two new spinoffs will likely hike investors’ overall total returns over the next several years.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers receive a two-week free trial.