Down 55%, Should You Buy the Dip on Pfizer?

Key Points

• Pfizer stands as one of the largest drug makers in the world.

• It faces normal industry challenges, but it also has a lofty payout ratio.

• Its latest acquisition shows what it is capable of doing to get onto a better path.

• 10 stocks we like better than Pfizer ›

Pfizer (NYSE: PFE) has a huge 7.1% dividend yield. That certainly compares favorably to the broader market's 1.2% yield and the average healthcare stock's yield of 1.7%. But Pfizer's lofty yield only exists because of a worrying 55% stock price decline since late 2022.

That kind of price decline doesn't happen by accident, which means you need to carefully consider whether this high-yield stock is worth adding to your income portfolio. Let's dig in and try to find out.

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What does Pfizer do?

Pfizer is one of the largest pharmaceutical companies in the world. It has a very long and successful history of finding, developing, and selling drugs, including dealing with the very difficult task of getting promising drugs approved for human use. It competes well with other drug makers and it is highly unlikely that the business is going to go away anytime soon.

That said, the stock has fallen a shocking 55% since late 2022. Even well-run businesses go through hard times and, pretty clearly, this is a hard time for Pfizer. There are two broad issues to consider.

First, there's been a shift in the view of drug makers, driven by reduced trust among consumers since the COVID-19 pandemic. That has been particularly troubling for Pfizer, which happens to make vaccines, which are an increasingly contentious issue in the public sphere.

The mood shift has come against another important trend for Pfizer, but one that is fairly normal in the pharma space. Drug companies are granted temporary exclusivity on new drugs because of the cost of drug development. When those drugs lose their patent protections generic alternatives can be produced, usually leading to a material drop in revenue for the original drug.

This is called a patent cliff in the industry and Pfizer is nearing just such a cliff starting in 2027, when oncology drug Ibrance comes off patent. That will be followed in 2028 with cardiovascular drugs Eliquis and Vyndaqel losing patent protections in 2028.

PFE data by YCharts

Pfizer is doing what needs to be done

Pfizer can't do much about the negative view of vaccines other than wait for the mood to shift. It likely will, given the long history of vaccines improving health outcomes. But the company can do something about patent cliffs, which basically require the healthcare giant to invest in new drugs.

One way it does this is with internal research and development. The problem is that R&D is an inherently lumpy process, so success isn't guaranteed and isn't likely to unfold on a set time frame that coincides with the company's patent expirations. A recent high profile failure came in the obesity drug arena.

But there's another option. Pfizer is large enough to simply go out and buy other companies with promising drugs. It did just that recently when it agreed to buy Metsera (NASDAQ: MTSR). The agreement calls for an upfront payment of $47.50 per share for Metsera, or about $4.9 billion in total. However, there are three contingent payments that could add up to $22.50 per share to the deal, increasing the overall cost by billions of dollars.

The key goal of the transaction is to get access to Metsera's promising drug pipelines, including in the obesity space. This is good news for Pfizer's business and management is, basically, doing what it needs to do to ensure the company's long-term success.

Before you run out and buy high yield Pfizer, however, consider two more facts. Pfizer's trailing 12-month dividend payout ratio is a lofty 90%, which suggests that the dividend may not be as secure as some investors might like. And the board of directors chose to cut the dividend in 2009 following Pfizer's acquisition of Wyeth Pharmaceuticals.

The $68 billion Wyeth deal was a larger transaction, but with such a high dividend payout ratio, the risk of a dividend cut following a material acquisition shouldn't be ignored. Also important to consider here is the fact that the drug candidates Pfizer is acquiring aren't guaranteed to be blockbuster drugs, which is why an earnout model was used in determining the price of the deal.

Buy the business, not the dividend

Given the steep price decline, there is turnaround appeal in Pfizer's stock today. And notably, management and the board are doing what is necessary to get the company back on track, namely investing (internally and via acquisition) in new drugs. It is highly likely that Pfizer does, eventually, get back on the growth track.

But the lofty payout ratio and a history of cutting the dividend suggests that income seekers should probably tread with caution. This pharma giant may not be as safe a dividend stock as you want it to be.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Pfizer. The Motley Fool has a disclosure policy.