Recent Buy (10)

Purchases for my FI Portfolio have been few and far between the last few years.  That's not for lack of opportunities or desire rather it had to do with our lives being on a roller coaster.  However, there's a light at the end of the tunnel as our main goal for this year is to get rid of all non-mortgage debt and then refocus our energy towards building up the portfolio.  

We aren't contributing fresh capital to our investments just yet as we're focused on getting rid of our non-mortgage debt.  However, that doesn't mean that we're not able to make new purchases thanks to the dividends that keep rolling in from our other positions.

I've typically been hesitant to own the big drug makers largely because they fall into the too hard category for me.  Analyzing the drug pipelines and potential addressable markets isn't exactly my forte.  That being said the business can be extremely profitable when done right.

On July 31st I purchased 30 shares of Pfizer at $39.00 per share.  The total cost basis, including commissions, for this lot came to $1,174.95 or $39.17 per share.

Pfizer is a Dividend Challenger with 8 consecutive years of dividend growth.  Based on the current quarterly payout of $0.36 per share the YOC for this slug of shares is 3.68% and I can expect to receive $43.20 in dividends over the next year barring any future increases from the new shares.
  



Due to this purchase my FI Portfolio's forward 12-month dividends increased to $7,207.65.

Dividends

As a dividend growth investor any potential investment must Jerry Maguire me, i.e. "SHOW ME THE MONEEEEEEYYYY!!!!".  I judge that based on a company's history of both paying and growing dividends to shareholders.  As you can see in the following graph, Pfizer doesn't have the cleanest dividend history with a 50% cut back in 2009; however, generally Pfizer has done pretty well.
 

*A full screen version can be found here.

What's pretty impressive is that despite the 50% cut back in 2009, Pfizer has still maintained a positive 10-year growth rate for every one of the 30 10-year periods since a dividend was initiated.  Pfizer's dividend growth, on the heels of the Viagra boom as well as many other drugs, was very strong with 10%+ annual growth the norm from 1981 through 2008.  Dividend growth has been much slower since the Great Recession as Pfizer has struggled to find a true blockbuster with the same kind of impact.

Of the 30 10-year periods, Pfizer's annualized dividend growth has ranged from 0.6% to 20.9% with a median growth rate of 11.5%.  However, since the dividend cut dividend growth has been much more measured with an average 1-year dividend growth rate of 8.0%.  

The 1-, 3-, 5- and 10-year rolling dividend growth rates since 1980 can be found in the chart below.  

*A full screen version can be found here.

That shouldn't come as much of a surprise as revenue has only grown 7% over the last 10 fiscal years.  However, over the last 5 years revenue growth has picked up to 8%.  Pfizer's payout ratio based off net income has averaged a pretty high 75% over the last 5 years and the TTM period.  Although the payout ratio based on free cash flow is much more palatable with an average of 54% over the same period.

Valuation

One valuation method that I like to use is dividend yield theory.  The idea behind dividend yield theory is that large, stable companies will see their dividend yields revert to their mean over time.  So when the yield is higher than "average", shares are undervalued and when it's lower than "average", shares are overvalued.

*A full screen version of this chart can be found here.

Since Pfizer initiated the dividend in 1980, market participants have valued shares at a 2.97% forward dividend yield on average.  The 5-year moving average dividend yield currently sits at 3.52% which is just slightly below the yield at the time of my purchase of 3.68%.  This suggests that shares are undervalued by just 4.4% or within the range of fair value.

Another valuation check is Pfizer's P/E ratios.  Based on 2019's EPS estimates, Pfizer is trading at a 13.7x P/E ratio and on 2020's estimates the P/E ratio is at 13.6x.  According to Morningstar, the 5-year average P/E ratio is 21.9x suggesting significant upside with a "fair price" being $62.  

Pfizer is also currently trading with a 6.5% EBIT/EV earnings yield or 15.3x EV/EBIT ratio.  That's a decent earnings yield for an intial entry point.

Conclusion

Pfizer's shares appear to be fairly valued based on dividend yield theory and potentially significantly undervalued based on historic P/E ratios.  Some of the overhang on the stock is likely due to the possibility of drug pricing reform depending on the who the next President is after next year's election.  Of course, Pfizer also just announced that it will be completing a spinoff/merger of its Upjohn unit with Mylan.

Should the share price continue to see further downside I would likely consider adding shares again around the $37 area or roughly 5% below my purchase price.

I've started compiling the dividend history, growth rates and dividend yield theory for many dividend growth companies.  Pfizer's can be found here and the remaining companies that I've already gathered the data on can be found here.  As new companies are added the list will be updated.

What do you think of my purchase of Pfizer?  What about other drug manufacturers?