Pfizer Trades Under 10 Times Forward Earnings With a Yield Near 6%. Here's What History Says Happens Next.

Pfizer (NYSE: PFE) is offering a dividend yield of roughly 6% today. That is well above the roughly 1% yield on offer from the S&P 500 index (SNPINDEX: ^GSPC) and the 1.4% average yield of pharmaceutical stocks. There are good reasons for the negative view of Pfizer, but investors may be ignoring the company's over 100-year history of success. Here's why you may want to consider buying this out-of-favor dividend stock while others are fearful.

Pfizer is facing normal industry headwinds

Pfizer's stock rocketed higher during the coronavirus pandemic, as investors myopically focused on the company's COVID vaccine. When COVID turned out to be a less serious long-term threat than originally believed, Wall Street dumped Pfizer. At this point, the stock is down more than 50% from its 2021 high. That is a big part of the story behind the high yield.

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However, there's another piece that is more fundamental to the pharmaceutical industry. Like all drug makers, Pfizer's drugs receive time-limited patent protections. When patents expire, generic versions of the medications can be produced. That generally leads to a dramatic decline in revenue from Pfizer's drugs. Right now, Pfizer is facing down some notable patent expirations. This is a completely normal dynamic in the pharmaceutical sector.

Patent expirations are why drug companies are always on the lookout for new drugs. The problem is that patent expirations follow a set schedule, but drug development does not. Pfizer's drug pipeline isn't producing major new drugs right now, and it looks like it may have to work through a period in which new drugs won't fully offset revenue lost to patent expirations. This isn't uncommon, either, but investors are likely focusing on the short term rather than the long term when it comes to Pfizer.

Pfizer fumbles the GLP-1 opportunity

A key driver of Wall Street's negativity is probably the GLP-1 weight-loss opportunity. Pfizer isn't even in the race yet, after one of its own drugs flamed out. No wonder the company's price-to-forward-earnings ratio is below 10x, while Eli Lilly (NYSE: LLY), the leader in the GLP-1 space, has a price-to-forward P/E of 24x.

To Pfizer's credit, however, it moved quickly to address its GLP-1 shortfall, buying a company with an attractive weight-loss drug still in development. It is also advancing a number of other drugs, notably in the cancer space, which is an extremely large treatment area. History suggests the company is dealing with a timing issue, not a fundamental shortfall of its business. Given enough time, Pfizer is highly likely to get back on track.

Will Pfizer's 6% yield survive?

Pfizer's management has stated clearly that it intends to support the dividend. In fact, the goal is to grow the dividend over the long term. Moreover, the company ended the second quarter with more than $11 billion in cash on its balance sheet, providing ample liquidity to support its business and dividend. While its dividend payout ratio is troublingly high, its cash dividend payout ratio is roughly 90%, so it still has the cash flow to cover the payout. (Dividends are paid out of cash flow, not earnings, which is why the financial impact of dividends is found on the cash flow statement.)

Given that Pfizer is facing patent expirations without new drugs to replace the income it will lose, there is clearly a near-term risk. That includes a risk that the dividend could be cut. However, even with a 50% dividend cut, the yield would remain attractively high. And given the stock price, you could easily argue a cut has already been priced in. Meanwhile, the company's long history of success suggests that it will eventually work through this period. More aggressive dividend investors may want to give it the benefit of the doubt, with the worst-case scenario likely being a still above-market and peer yield.

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