When investors think about health care stocks, growth is often the first word that pops into their minds. This happens with good reason, as health care issues are often quintessential growth stocks. By growth stock, we mean the shares of a company whose earnings are increasing at a higher rate than that of its peers. In general, growth-oriented investors focus on the denominator in the price-to-earnings (P/E) ratio, looking for companies or industries where high expected earnings growth will propel stock prices upward. Such issues typically do not offer high dividend yields, as company managers usually prefer to reinvest profits in the business in order to take advantage of high returns on capital and support bottom-line growth, rather than distribute a portion of net income to shareholders in the form of dividends.
That said, there are healthcare companies that pay dividends, a number of which are quite generous. To find some of these issues, we screened the Drug, Medical Supply, Medical Services, Pharmacy Services, and Biotechnology industries. First, we looked for companies with dividend yields above 1% and then, to help ensure the dividends were sustainable, we limited the results to those companies with long-term debt as a percentage of total capital below 50%. Most of the highest-yielding stocks that our screen returned were drug companies. Not too surprisingly, only one Biotech firm made the cut.
To view the full list, subscribers can use the noted criteria to construct a search using Value Line’s online tools. Here, we highlight Johnson & Johnson (JNJ – Free Analyst Report), Merck (MRK – Free Analyst Report), and PDL BioPharma (PDLI), three of the 34 companies that our recent search turned up.
Johnson & Johnson
Johnson & Johnson manufactures and sells a broad line of health care products, including pharmaceuticals, medical devices, diagnostics, and consumer offerings. The business is very global, with international sales accounting for about half of total revenues.
While earnings in 2010 are being held back by costs associated with the TYLENOL recalls, profits in 2011 and beyond should benefit from a promising drug-development pipeline, geographic expansion plans (Brazil, China, and India), and an active acquisition program. Recently introduced products include biologics to treat psoriasis, arthritis, and schizophrenia in adults, as well as a disposable contact lens made with silicone hydrogel. Via acquisition, J&J has expanded its presence in some of the fastest-growing healthcare segments, from orthopedic implants to cancer drugs. Moreover, with an excellent balance sheet and ample free cash flow, the company’s dividend appears to be very safe.
Merck is a leading manufacturer of human and animal health care and specialty chemical products. Important product names include Singulair (asthma), Zocor (cholesterol), Fosamax (osteoporosis), Vasotec (high blood pressure); and Prilosec (acid reflux). The company invests about 20% of sales annually into research and development to keep its product pipeline flowing.
Although healthcare reform is causing some uncertainty, Merck’s prospects should be aided by the expanded global footprint and product portfolio from its merger with Schering-Plough. In any case, the dividend should continue to be well covered by future cash flows.
PDL BioPharma, Inc. develops humanized antibodies and other proteins for the prevention or treatment of various disease conditions. With fundamental patents in the United States, Europe, and Japan, the company receives royalties on eight antibodies marketed by other firms.
The intermediate-term picture, however, is clouded by patent litigation with a former customer and by uncertainty regarding the company’s strategy to acquire additional patents to generate future royalty streams. So, while the high dividend yield makes this speculative stock interesting, the fundamental outlook is too uncertain for conservative investors without a high tolerance for risk.
At the time of this article's writing, the authors did not have positions in any of the companies mentioned.