Forget T-bills, Buy These Pharma Dividend Stocks Instead

Before you go, we thought you'd like these...
Before you go close icon

Even with yesterday's stock rally, the yield on a 10-year T-bill was less than 2.3% yesterday. I understand the whole flight-to-safety thing, but who the heck is buying those things? Pharma stocks offering dividend yields that are double the current interest rates on 10-year T-bills look like a much better risk-reward proposition.

But they're not guaranteed!
True enough. T-bills are backed by the full faith of the U.S. government, which despite what Standard & Poor's might say, is still as valuable as it gets. When you buy stocks, there's a risk that the share price will decrease.

But you're giving up an awful lot for that safety. As an experiment, I figured out how much pharmas would have to fall in order to break even with T-bills.

Company

Dividend Yield

Stock Price (Decline) Required to Match T-bill Return

Pfizer (NYS: PFE) 4.4%(21%)
Merck (NYS: MRK) 4.8%(25%)
Eli Lilly (NYS: LLY) 5.5%(32%)
Johnson & Johnson (NYS: JNJ) 3.5%(13%)
GlaxoSmithKline (NYS: GSK) 5.0%(27%)
Bristol-Myers Squibb (NYS: BMY) 4.6%(23%)

Source: Capital IQ, a division of Standard & Poor's, and author calculations.

That's an awful lot of protection to the downside. And it assumes dividends won't increase over the next 10 years, which is a fairly conservative assumption. Johnson & Johnson has raised dividends for the last 49 consecutive years.

The calculations also don't take into account reinvesting dividends, which would increase the potential returns even further compared with T-bills.

What about the patent cliff?
It's true, many pharmas will lose a substantial portion of their revenue when big drugs like Pfizer's Lipitor and Bristol and Sanofi's (NYS: SNY) Plavix go off patent. As soon as cheap generics move in, sales head toward zero almost instantly. The sales decline sometimes even starts a few months early as pharmacies deplete their stocks, anticipating the arrival of the generics.

The thing is everyone knows the patent cliff is coming. There are no surprises here; the inevitable declines in revenue are priced in. Eli Lilly, for instance, trades at a P/E under 9. That's superficially crazy cheap because everyone knows its earnings are going to drop over the next few years.

Getting paid to wait
If we're comparing investments in pharmas to 10-year T-bills, shouldn't we be looking at what pharma's value will be in 10 years? Even in the long drug development cycle, 10 years is plenty of time to turn things around. A decade from now, most of the early-stage drugs will have progressed through phase 3 testing and will be on the market if their efficacy and safety pan out.

If you have that long of a time frame, Eli Lilly might be a decent bet. There's little in the late-stage pipeline that will offset the near-term revenue decline, but the company does have a whopping 58 molecules in phase 1 and phase 2 development that could help increase revenues well after the patent cliff sets in.

For a more near-term investment, consider Bristol-Myers, which has had a string of solid approvals lately, including melanoma drug Yervoy and kidney transplant treatment Nulogix. The company is still guiding for post-Plavix 2013 earnings just a little lower than last year's level, but I think that might be boosted slightly when management gives its 2012 guidance later this year.

Looking for more options?
If you have a long-range forecast -- and why else would you be considering 10-year T-bills? -- you can likely make considerably more with dividend stocks with only a modest increase in risk.

To decrease that risk further, consider investing in divided stocks outside of the pharmaceutical industry as well. The Motley Fool's free report "13 High-Yielding Stocks to Buy Today" offers up additional suggestions. Pick up your copy by clicking here.

At the time this article was published Fool contributorBrian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Click here to see his holdings and a short bio. The Motley Fool owns shares of Johnson & Johnson and GlaxoSmithKline. Motley Fool newsletter services have recommended buying shares of GlaxoSmithKline, Pfizer, and Johnson & Johnson, as well as creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners