Investing in dividend growth stocks is one of the most famous strategies today, but unfortunately, finding lucrative opportunities has become increasingly difficult as a result of the record bull run. Stock prices of many renowned dividend-paying companies have appreciated double or triple digits since last March, and this calls for extreme caution from investors whose objective is to generate a safe and steady income stream by investing in stocks.
Pfizer Inc. (PFE, Financial), one of the largest pharmaceutical companies in the world, shot to fame last year as it was recognized as one of the top vaccine developers to fight the Covid-19 pandemic. Given this backdrop, it comes as a surprise to me that Pfizer stock is down 5% in the last 12 months and is up just 17% in the last five years.
Pfizer is more than just a vaccine maker for the current pandemic, and its pipeline is promising. At the market price of around $34 on Feb. 22, Pfizer shares yield 4.5%, and quarterly dividend payments can be expected to increase in the coming years along with corporate earnings.
The outlook is promising
The vaccine developed in partnership with BioNTech (BNTX, Financial) to fight the Covid-19 pandemic crisis will be a short-term driver of revenue for Pfizer, and some investors are entirely focused on this vaccine whereas the company is generating billions of dollars from a well-established portfolio of drugs that have been in the market for many years.
Pfizer failed to come up with innovative drugs in the 10 years ended in December 2015, and its progress in finding cures for certain varieties of cancer and heart diseases faltered in this period as well. This is one of the primary reasons behind the lackluster performance of its stock in the market. However, the company has recovered strongly from these lows, and its clinical trial success rate has improved dramatically in the last five years against the industry and its own historical track record.
Source: Investor presentation
The decision to invest billions of dollars in improving the research and development process has a lot to do with this recent success, and the company is well-positioned to reap the rewards of these investments in the next five years. According to company executives, Pfizer will likely report an annualized revenue growth rate of at least 6% through 2025 without considering the contribution from the Covid-19 vaccine. This will be a sharp improvement from the decline in revenue reported by Pfizer in the five years from 2015 to 2020.
According to data from company filings, Pfizer has many products in Phase 3 clinical trials, and some of these drugs and vaccines, such as its treatment for hemophilia A and prostate cancer, could turn out to be breakthrough developments that could lead to strong earnings growth.
The company remains focused on reducing operating costs in a bid to improve profit margins as well, and these efforts have already delivered significant cost savings for the company. For instance, between 2017 and 2020, Pfizer has saved approximately $1.6 billion by streamlining its business model. Last November, the company completed the spin-off of its Upjohn business, which combined with Mylan to form a new entity named Viatris Inc. According to company filings, this transaction is expected to save Pfizer more than a billion dollars by 2022.
Over the last five years, Pfizer has become a more efficient company and its success rate in Phase 3 clinical trials has increased to over 85% from 70%. These numbers indicate that the company is back on track to report stellar earnings growth in the next five years, but the market is yet to react to this expected increase in profitability.
The dividend is safe and attractive
As a dividend growth investor, one needs to consider not only the yield but also the ability of the company to increase the payout in the future. Pfizer has increased its dividend each year since 2011, and the most recent dividend cut came during the 2008 financial crisis. Even though the payout has grown considerably, Pfizer has successfully covered shareholder distributions with free cash flow for more than 20 years, and this is a testament to the safety of the dividend. In the fourth-quarter earnings call, Pfizer CFO Frank D'Amelio confirmed the management's intention of maintaining the annual payout at the current rate in the foreseeable future, which adds another layer of assurance for investors who are worried about a potential dividend cut.
The quality of a management team can often be evaluated from their capital allocation decisions, and Pfizer exhibited its maturity from this perspective by not rushing to raise dividends despite generating better-than-expected cash flows last year due to a temporary revenue boost. Commenting on the stance of the company, D'Amelio said:
"While the COVID-19 vaccine has created a new cash flow stream, there is no change in our capital allocation priorities. We remain focused on growth initiatives and the growing dividend, though at a slower rate."
The measured approach to dividend hikes should bode well with long-term-oriented investors as it highlights the fact that company management is focused on securing the sustainability of future earnings.
The valuation is attractive
Pfizer stock is trading at a forward earnings multiple of just 13.21 in comparison to the health care sector average of 33.13, indicating the company is significantly undervalued in the market.
Wall Street analysts have assigned a median target price of $39.89 per share for Pfizer, which implies an upside of 16.4% from the current market price.
If the company successfully reaches the marketing stage of at least a few drugs that are currently in its pipeline, Pfizer is likely to beat earnings estimates handsomely, which could trigger a strong upward movement in its stock price. The deeply undervalued nature of Pfizer should add a layer of comfort for dividend growth investors.
Takeaway
Pfizer Inc. is trading at cheap valuation multiples and its shares yield over 4.5%. In addition to the lucrative gains that can be expected from Pfizer in the coming years, investing in the company serves as a hedge against a possible market crash because of the low correlation between the health care sector and the S&P 500 index. Tactically investing in Pfizer, therefore, is likely to help value investors generate alpha returns in the next few years, in my opinion.
Disclosure: The author does not own any shares mentioned in the article.
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