Published January 5th, 2017 by Bob Ciura
The health care sector is a great source of dividend stocks. There are many health care stocks among the Dividend Aristocrats, which are companies that have raised dividends for 25 consecutive years.
You can see the entire list of all 50 Dividend Aristocrats here.
There are many reasons for this. First, large health care companies have highly profitable business models. Many have been in operation for decades, and have built strong brands over time.
Furthermore, consumers often do not have a choice when it comes to their health care. Many consumers have to continue taking medication and receiving health care, even when the global economy enters recession.
This provides pricing power, and insulates many health care companies from economic downturns.
And, the health care sector was virtually flat over 2016 while the S&P 500 as a whole posted double digit gains. This makes the sector a prime place to look for high quality dividend growth stocks.
There are a number of health care companies that use a portion of their profits to pay attractive dividends to shareholders, and grow those dividends over time.
The following stocks all rank highly using The 8 Rules of Dividend Investing. This article will discuss the top seven health care stocks to buy today.
No. 7: Becton, Dickinson and Company (BDX)
Becton, Dickinson and Company manufactures medical supplies, which include diagnostics, infection prevention, surgical equipment, and diabetes management products.
The company benefits from a leadership position in its industry and structural growth due to the aging population. As a result, it has generated strong growth over the past five years.
Source: 2016 Analyst Day presentation, page 4
Becton, Dickinson and Company has a price-to-earnings ratio of 36 on a trailing basis. This might make the stock seem significantly overvalued, since the S&P 500 Index has an average price-to-earnings ratio of 26.
But on a forward-looking basis, the stock is much more reasonably valued. The company’s reported results over the past year include significant one-time charges that negatively affected its GAAP earnings-per-share.
For example, in fiscal 2016 Becton, Dickinson and Company incurred restructuring and integration costs that reduced its GAAP earnings-per-share by $526 million and $192 million, respectively.
These are non-recurring costs. On an adjusted basis, Becton, Dickinson and Company generated earnings-per-share of $8.59 in fiscal 2016. This was a very strong 20% year-over-year increase.
The stock is much more attractively valued using adjusted earnings-per-share. On this basis, the stock trades for a price-to-earnings ratio of 19. This indicates that the stock is actually undervalued compared with the S&P 500.
Going forward, the company projects 5% annual revenue growth and double-digit earnings growth from fiscal 2017-2019.
Revenue growth will be attained through growth in the emerging markets. Earnings-per-share growth will be achieved with a combination of revenue growth and cost cuts.
Source: 2016 Analyst Day presentation, page 12
Becton, Dickinson and Company has been very successful at expanding profit margin over the past several years. Operating margin expanded by 200 basis points in fiscal 2016, and management expects another 175-225 basis point expansion in fiscal 2017.
Operating margin expansion was fueled by global scale, automation, and business process enhancements.
This has led to excellent free cash flow generation. From fiscal 2012-2015, the company generated $5 billion of free cash flow. Going forward, the company projects $8 billion of free cash flow from fiscal 2016-2019.
With its steady earnings growth, the company has raises its dividend each year. Becton, Dickinson and Company has raised its dividend for 45 consecutive years, including a recent 10.6% increase.
As a result, Becton, Dickinson and Company is a Dividend Aristocrat.
The stock has a below-average dividend yield, of 1.8%. But it makes up for this with high dividend growth.
No. 6: Medtronic PLC (MDT)
Medtronic is a global medical device company. It operates four business segments:
- Cardiac and vascular (35% of sales)
- Restorative therapies (25% of sales)
- Minimally invasive therapies (34% of sales)
- Diabetes (6% of sales)
The company is enjoying broad-based growth over its current fiscal year.
Source: Q2 Earnings presentation, page
For example, the cardiac and vascular and restorative therapies segments each generated 1% revenue growth over the first half of the year.
Meanwhile, minimally invasive therapies and diabetes revenue each increased 2% in the same period.
Most of the growth is coming from the international regions, and in particular the emerging markets. Medtronic’s U.S. revenue declined 1% through the first six months of the year.
By contrast, revenue in the emerging markets has grown at a much faster rate across Medtronic’s product portfolio.
In the same six-month period, emerging market revenue increased 9% in cardiac and vascular, 10% in minimally invasive therapies, and 15% in diabetes.
Two markets in particular are especially attractive for future growth. China, Medtronic’s largest emerging market, grew revenue by 11% last quarter. Growth was due to double-digit growth in minimally invasive therapies and diabetes.
The other key market is Russia, where revenue grew over 20% as a result of strong momentum in the cardiovascular and minimally invasive therapy groups.
Moving forward, one area Medtronic is targeting for future growth is diabetes. Medtronic does have a presence in this therapeutic area, but it is by far its smallest operating segment.
Source: Jefferies Diabetes Summit presentation, page 4
This should be a very good year for Medtronic. The company expects fiscal year 2017 revenue growth to rise in the mid-single digit range on a constant currency basis. Earnings-per-share are expected to grow double-digits.
Much of this is due to the company’s acquisition of Covidien. Acquisitions added 120 basis points to revenue growth last quarter. And, the acquisition will provide a significant boost to operating margin, which expanded by 150 basis points year-over-year.
Medtronic is on track to realize $225-$250 million of cost savings in the current fiscal year. Moving forward, the company expects $850 million of synergies by the end of the fiscal 2018.
Medtronic is a great stock for investors who are looking for a combination of an above-average yield and high dividend growth.
The stock has a 2.4% current dividend yield. Furthermore, Medtronic recently increased its dividend by 13%. Medtronic is a Dividend Aristocrat, and has increased its annual dividend payment for the past 39 consecutive years.
No. 5: Abbott Labs (ABT)
Abbott Labs has approximately 74,000 employees and its products are sold in more than 150 countries around the world.
The company operates four segments:
- Nutrition (33% of sales)
- Diagnostics (23% of sales)
- Established Pharmaceuticals (19% of sales)
- Medical Devices (25% of sales)
Abbott has been extremely successful at creating shareholder wealth over the long term. It has achieved this through a balanced business model, both in terms of product focus and geographic markets.
Source: JP Morgan Healthcare Conference, page 3
Abbott enjoys a dominant position across its core operating businesses. For example, it is the number one company in adult nutrition, as well as in pediatric nutrition. And, it has the number one blood screening business.
It is leveraging its strong brands to pursue a significant portfolio transformation. For example, the company recently sold its medical optics business for $4.3 billion.
Abbott’s medical optics business included cataract surgery, laser vision correction, and corneal care products such as contact solution and eye drops
Abbott is using the proceeds to help pay for its $25 billion acquisition of medical device company St. Jude Medical.
This will make Abbott a global medical device giant. St. Jude Medical has an entrenched position in high-growth product areas like atrial fibrillation, heart failure, and chronic pain management.
The combined company will have an iron-clad grip on the $30 billion cardiovascular market, and hold the number one or number two position across the cardiovascular device industry.
Since the two companies have such complementary business models, the acquisition should go smoothly. Abbott expects the acquisition will add $0.21 to fiscal 2017 earnings-per-share, and another $0.29 to fiscal 2018 earnings-per-share.
Some of this growth will be comprised of cost synergies. The acquisition is projected to result in $500 million of annual cost savings by 2020.
In addition, Abbott is a great play on emerging-market growth. Not only will the company benefit from aging global populations, but it will also benefit from high-growth geographic markets.
The company derives 50% of its annual sales from emerging markets, such as China and India. These are nations with large populations and higher economic growth than developed markets like the U.S.
Source: JP Morgan Healthcare Conference, page 6
Abbott’s growth in the U.S. and the emerging markets will allow the company to continue raising its dividend, as it has done for 45 years in a row.
The stock has a current yield of 2.7%.
No. 4: Johnson & Johnson (JNJ)
J&J is arguably the gold standard among dividend growth stocks in the health care sector. It has raised its dividend for a whopping 54 years in a row. This makes the company a Dividend King – an elite group of stocks with 50+ consecutive years of dividend increases.
The stock has seen an extended rally over the past several years, which has elevated its valuation. Shares now trade for a price-to-earnings ratio of 20.
While this is lower than the S&P’s average price-to-earnings ratio of 26, J&J stock has held an average price-to-earnings of 16 since 2000. As a result, the stock is valued above its own multi-year average.
Still, investors should not be afraid to buy J&J stock at this level. It can still achieve satisfactory returns over the long-term, from earnings growth and its dividends.
For example, it would not be difficult for the stock to generate 10% or greater annualized returns. Working backwards, the company would need to achieve approximately 7.3% annualized earnings-per-share growth to reach double-digit returns, given its current 2.7% dividend yield.
This is a very reasonable growth target for the company. Over the first three quarters of 2016, adjusted earnings-per-share, which excludes the effects of currency and non-recurring costs, rose 8.2% year over year.
Last quarter was particularly strong for J&J, which delivered 12.8% adjusted earnings-per-share growth.
Source: Q3 Earnings presentation, page 1
Future growth should be fueled by J&J’s balanced business model. The company operates in pharmaceuticals, medical devices, and consumer health care products. It has a large presence in all three groups.
J&J’s pharmaceutical business is growing at the fastest rate right now. Organic revenue increased 9.1% over the first three quarters of 2016.
Two of the most attractive areas in pharmaceuticals are immunology and oncology, which grew sales by 17.8% and 29.7% last quarter, respectively.
J&J’s existing pharmaceutical portfolio includes 11 assets that each generate $1 billion or more in annual revenue. 10 of these brands are growing, six of which are growing in the double-digits.
There is plenty of growth potential up ahead, thanks to the company’s robust pipeline. J&J plans to file 40 line extensions, 10 of which hold $500 million or more in annual revenue potential.
Source: Q3 Earnings presentation, page 27
In addition, J&J is developing 10 assets with $1 billion or more in annual revenue potential, to be filed through 2019.
This year, J&J expects to generate sales of $71.5-$72.2 billion, and adjusted earnings-per-share of $6.68-$6.73. Analysts expect the company to grow earnings-per-share by 12.6%.
As a result, J&J takes a high spot on this list because of its strong brands and excellent pharmaceutical pipeline. It is a low-risk stock with reliable returns.
No. 3: Cardinal Health (CAH)
Cardinal Health cracks the top three, because it has a strong grip on the distribution industry. It acts as a distributor of health care supplies.
The company has a huge network, which consists of more than 25,000 pharmacies. Cardinal Health also supports more than 70% of hospitals in the U.S. It serves 2 million patients with nearly 40,000 home health care products.
And, it manufactures or sources nearly 2.8 billion individual consumer healthcare, home medical equipment, and over-the-counter products each year.
The past year has not been kind to Cardinal Health shareholders. The stock has declined 17% in the past 12 months. This is because the company is struggling with significant price deflation in its core pharmaceutical business, which makes up approximately 90% of its annual revenue.
Revenue continues to grow due to new customer additions, but price deflation has significantly eroded margins. For example, while revenue increased 14% last quarter, operating profit declined 14%.
The good news is that the company has prepared for this by investing aggressively to grow the business. It has deployed $8.5 billion in acquisitions and internal R&D over the past five years.
Source: 2016 Annual Report, page 9
It has also allocated more than $5 billion in cash returns to shareholders. This demonstrates the cash generating abilities of the business.
Cardinal Health stock screens very well for value and income. The stock has a price-to-earnings ratio of 15 using adjusted earnings, with a 2.5% dividend yield. It is cheaper than the S&P 500 on a valuation basis, with an above-average dividend yield as well.
The company is a sure bet for dividend growth. Cardinal Health increased its dividend each year for 31 years in a row.
Furthermore, Cardinal Health raises its dividend at very high rates. Most of the health care stocks on this list can be counted on for dividend growth in the mid-to-high single digits.
But Cardinal Health is likely to pass through double-digit dividend increases each year going forward, thanks to strong earnings growth rates. Analysts on average expect the company to grow earnings-per-share by 20% in 2016, and 4% in 2017.
Source: Q1 Earnings presentation, page 13
Over the long-term, Cardinal Health management projects 10%-15% annualized growth in adjusted earnings-per-share. This will be more than enough earnings growth to generate satisfactory returns, and allow the company to raise its dividend each year.
No. 2: Novo Nordisk (NVO)
Coming in at number two is Novo Nordisk. Novo Nordisk is based in Denmark. It operates in diabetes, obesity, and biopharmaceuticals.
Source: Q3 Earnings presentation, page 23
Investors have bid up valuations across the health care sector, because of their high-quality business models. Share prices have risen faster than earnings growth for many companies, which has resulted in elevated price-to-earnings ratios.
But Novo Nordisk is an oasis stock for investors searching for value. Novo Nordisk stock declined 36% over the past one year, which has compressed its valuation and raised its dividend yield.
Sentiment has become much more negative for the company, as it struggles with fierce generic competition. It is fighting though the loss of patent exclusivity for products within hormone replacement therapy, as well as intensifying competition in diabetes and biopharmaceuticals.
The company saw a great deal of turmoil in 2016. Last year, management reduced its long-term profit growth target to 5% from 10%, which it now views as no longer achievable. In addition, the company announced a major restructuring, and laid off 1,000 employees.
Finally, the CEO announced his resignation, after 34 years with the company.
However, the company has a turnaround plan that appears to be working. Novo Nordisk reported strong growth rates over the first three quarters of 2016.
Source: Q3 Earnings presentation, page 5
Despite patent expirations and intensifying generic competition, the company is still enjoying strong growth for its flagship insulin products, Victoza and Tresiba.
Source: Q3 Earnings presentation, page 13
The company is steering future investment toward the most attractive opportunities, while scaling back in areas that are not as productive.
Novo Nordisk is re-focusing its R&D on diabetes, to keep up with the heightened level of competition. It still sees diabetes as a critical therapeutic area, and for good reason.
According to the company, 415 million people suffer from diabetes worldwide.
As of the end of the third quarter, Novo Nordisk received final regulatory approval for two new diabetes medications, Xultophy and a faster-acting insulin aspart. It has one drug in Phase III trials, and another four in Phase II.
Analysts expect Novo Nordisk’s earnings-per-share to rise 18.6% in 2016, and another 2% in 2017. This growth is thanks largely to the company’s re-focused research & development.
A return to sustainable growth should improve investor sentiment in 2017. The stock trades for an attractive price-to-earnings ratio of 17.
This makes Novo Nordisk a cheap turnaround bet.
No. 1: AbbVie (ABBV)
Taking the top spot is pharmaceutical giant AbbVie, which was spun off from Abbott Labs. The reason why AbbVie is the number one health care stock for 2017 is because it has everything an investor could want.
AbbVie has a strong pharmaceutical portfolio. It is a growth stock, a value stock, and an income stock all-in-one.
AbbVie is generating excellent growth rates, thanks to its excellent pharmaceutical properties. Its flagship brand is Humira.
Humira has fueled excellent growth for the company. For example,
One risk to the company that investors should keep in mind is that Humira is about to lose patent exclusivity. This is a concern, since Humira by itself represents more than half the company’s annual revenue.
Fortunately, AbbVie has a multi-faceted plan to keep growing, even after Humira goes off patent.
Source: Jefferies 2016 Healthcare presentation, page 3
AbbVie has prepared for this eventuality by investing significant resources in new products. The company has eight de-risked late stage assets that are projected to cumulatively generate $25-$30 billion in annual revenue after 2020.
Source: Jefferies 2016 Healthcare presentation, page 6
Moreover, management still expects Humira to generate $18 billion in annual revenue by then, so it is not as if the drug will disappear entirely.
The company expects continued growth this year. At the midpoint of management’s 2016 forecast, AbbVie forecasts 12% growth in adjusted earnings-per-share.
In addition, the stock has an appealing valuation. AbbVie stock trades for a price-to-earnings ratio of 13.4 using adjusted earnings. It is significantly cheaper than the S&P 500.
Not only that, but AbbVie stock offers a 4% dividend yield. This is almost unheard of among U.S. based health care stocks. AbbVie’s dividend yield is double that of the average dividend yield in the S&P 500.
Plus, the company is a high dividend growth stock. It recently increased its dividend by 12%.
AbbVie has a current annualized dividend payout of $2.56 per share. The company expects adjusted earnings-per-share of $4.80-$4.82. At the midpoint, the stock carries a forward payout ratio of approximately 53%.
This is a modest payout ratio. Combined with future earnings growth, this leaves plenty of room for AbbVie to continue increasing dividends.
AbbVie offers double-digit earnings growth and dividend growth, and a cheap stock. Consequently, it is the number one health care dividend stock to buy today.