Better Dividend: Merck & Co., Inc. (MRK) or Pfizer Inc. (PFE)?

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Merck & Co., Inc. (NYSE:MRK)‘s dividend yield is 4.2%. Pfizer Inc. (NYSE:PFE)‘s is only 3.5%. Merck’s is higher so it must be a better choice for dividend investors.

Not so fast.

Unless you’re content with a 4.2% yield, and you’re convinced that it can last long, you have to dig beyond the dividend yield to see which drugmaker is a better stock to own.

Merck & Co., Inc. (NYSE:MRK)A little history
Neither company has a stellar track record when it comes to dividends. They don’t compare to Abbott Laboratories¬†(NYSE:ABT), which raised its dividend for 40 years in a row, and probably would have continued the trend had it not spun off its pharmaceutical division into AbbVie Inc (NYSE:ABBV), sending a good chunk of its cash flow with it. Both Abbott and AbbVie will likely continue the tradition of raising their dividends, but they’ll do it from smaller individual bases.

Pfizer cut its dividend in half when it decided to purchase Wyeth in 2009. Since then, it’s made four dividend raises, but its dividend of $0.24 per quarter is still well below the $0.32 per quarter it handed out before the cut.

Merck hasn’t cut its dividend recently, but it doesn’t have a long history of raising it either. Merck’s dividend was frozen at $0.38 per quarter after Vioxx went off the market in 2004, until 2011, when Merck finally raised the dividend. It was raised again last year to the $0.43 it currently sits at.

Based on the free cash flow and dividends from the most recent reporting period — fourth quarter 2011 through third quarter 2012, because neither company has filed their 10-K for 2012 yet — it appears that both companies should have no problem funding the dividend in the future.

Company Dividend Payments TTM (in millions) Free Cash Flow TTM (in millions) Payout Ratio
Pfizer $6,439 $15,628 41%
Merck $5,001 $9,667 52%

Source: S&P Capital IQ.

Beyond the dividend
Investors shouldn’t be content with just the dividends. While the dividends pay out like a fairly nice bond, owning the stock comes with increased risk compared to a bond. You really need to supplement the dividend with capital appreciation of the stock to make owning either durgmaker worthwhile. Holding a large pharma isn’t risk free — Vioxx anyone? — so investors need to be rewarded for it; 3% to 4% return isn’t going to cut it.

Figuring out which company will increase its valuation is a little more complicated than analyzing the prospects for the dividend. There’s a lot of moving parts: revenue growth from current drugs, the company’s pipelines, drugs going off patent, changes in margins.

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