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Summary

  • Investors looking for dividends won't be impressed with the Heath Care SPDR ETF's yield of around 1.5%.
  • However, when looking at the ETF's components, investors can find yields that satisfy long term out performance.
  • Below is a list of 4 names that provide safe, growing dividends along with business to support looking at a long term investment.

Over the past few years the ETF market has gained traction as a viable and safe alternative to owning individual stocks. Because ETFs - exchange traded funds - bundle a collection of stocks together under one banner, investors can buy into these funds and be shielded from company specific surprises that cause volatility. Certain ETFs even pay dividends from the collection of stocks they own. For the investor looking for an outsized dividend return, however, ETFs may not be the best alternative to stocks in the long run. When looking at the healthcare sector, for example, a popular ETF that mirrors the performance of the industry as a whole is the Health Care SPDR ETF (NYSEARCA:XLV). This fund pays a quarterly dividend of $.20 for a yield of 1.48%. This payout, while better than nothing, misses out on the potential dividend return that many healthcare stocks have to offer. Below is a list of 4 stocks that are XLV components that have both higher yields and higher dividend growth than the ETF can muster:

NameYield (%)Payout Ratio
Pfizer (NYSE:PFE)3.4.33
AbbVie (NYSE:ABBV)3.3.62
Eli Lilly (NYSE:LLY)3.3.7
Quest Diagnostics (NYSE:DGX)2.4.32

Pfizer

Pfizer is a research based pharmaceutical company whose goal is to provide new treatments and products to fill current unmet medical need. The company makes money through an intensive research and development pipeline of drugs that are given patent exclusivity for a set number of years. This exclusivity gives Pfizer a monopoly on sales of the product until what's called the "patent cliff", where the exclusivity of the drug expires and it becomes available over the counter at much lower prices. Pfizer's current pipeline has 7 products awaiting regulatory approval and 20 products in Phase III production. Among the projects in Phase III is a compound called Xeljanz, which combats psoriasis and psoriatic arthritis. Psoriasis is an inflammatory disease affecting 3% of the world's population, which makes Pfizer's research vital not only for its business model but for the progress of world health.

Pfizer's earnings over the past year have been stalling due to the recent loss of products to patent expiration, including its former best-selling drug - Lipitor. In an effort to jumpstart its prospects for 2014-15, the company has been looking to put its massive $70 billion overseas cash pile to work, and has recently unveiled talks to buy AstraZeneca (NYSE:AZN) for a combination of a portion of this cash and Pfizer stock. While AstraZeneca seems reluctant to agree to an acquisition, this move by Pfizer shows initiative to bring value to shareholders and willingness to execute high-profile deals in order to do so.

In addition to their impressive cash position, Pfizer rewards shareholders with a 3.4% dividend yield at today's stock price. This dividend is almost three times that of the XLV, and is supported by Pfizer's strong financial position to continue distributions. Pfizer currently pays out only 33% of its earnings in the form of dividends, which means that the company has the financial capability to double its payout and still have plenty of cash left over to operate its business. Even if earnings stagnate in the near term, Pfizer has the coffers to continue to pay and raise its dividend until its large cash position is put to good use and its pipeline produces sales that excite.

AbbVie

Abbvie is another big name in the pharmaceutical industry, with over 25,000 employees and operations in 170 countries around the world. AbbVie is the product of a successful spinoff from Abbott Laboratories (NYSE:ABT) in 2013, and has since shown success as an independent company. Their flagship product, Humira, has shown strong growth since its introduction in 2002, and is the world's top selling prescription drug. AbbVie relies on Humira for almost 60% of their sales, which makes 2016 - the year Humira loses patent protection - a potential long term negative going forward. Sales of the drug are expected to continue to rise after expiration, however, because generic drug makers may have a hard time creating and selling similar forms of the product. This gives AbbVie time to develop its pipeline further to offset its outsized dependence on Humira.

AbbVie reported its most recent quarterly results on April 25, and surprised the Street with an impressive performance. Earnings of $.71 beat analyst estimates due to increased margins and accelerated global sales. Management highlighted advancements in its pipeline as well as accomplishment of key objectives for its upcoming products, including an HCV Interferon-Free Combination drug to combat liver disease. This therapy, due to begin next year, will complement AbbVie's existing products in both the United States and Europe as each of these nations give regulatory approval for sale of the drug. AbbVie's strong sales position and promising pipeline give it favorable growth prospects going into 2015 and beyond.

ABBV also provides shareholders with a bountiful dividend in addition to its solid business performance. Abbvie currently pays $1.68 in dividends per share of stock, which translates to a 3.3% yield at current levels. During their earnings conference call, management outlined expectations of $2.63 - $2.73 in EPS for this year. If this expectation pans out, ABBV will pay out around 62% of their earnings in the form of dividends. This distribution ratio, while not low, still provides AbbVie enough flexibility to raise payouts in the future, even with zero future earnings growth. And with Humira sales continuing to grow and a strong pipeline to back these sales up, AbbVie should have no problem maintaining and raising its distributions in the future and keeping shareholders happy.

Eli Lilly

Eli Lilly is another large cap drug manufacturer researching and marketing products in both the human pharmaceutical and the animal health industry. The company's pipeline of drugs in development includes 8 drugs undergoing Phase III research and 3 awaiting regulatory approval. LLY's most recent achievement came on April 21 when the FDA approved Cyramza, Lilly's drug to treat patients with advanced stages of gastric cancer. This is the first drug of its kind for patients with this disease, which is expected to give Eli Lilly a boost in earnings for 2014. This is a much needed development, as the company is currently fighting the negative impact of two big patent expirations - Evista and Cymbalta. When LLY reported their most recent earnings report on April 24, both revenues and earnings saw significant decline due to the loss of exclusivity for these two blockbuster drugs. To try to combat these losses, the company cut costs by 14% year over year and put a freeze on all employees' base salaries for the rest of 2014. This, along with the anticipation of new drugs coming down the pipeline, should help Eli Lilly manage the rough patch they're currently working through.

Even with short term pressure on their business, Eli Lilly still has the financial support to distribute $1.96 per share in dividends to its shareholders. This payout gives the company's stock a 3.3% yield at today's prices, which should comfort shareholders while the business recovers from the expirations. Eli Lilly outlined in their earnings conference call expectations to make around $2.72 - $2.80 in earnings this year, which is more than enough to cover the current dividend. This should give relief to investors who might be worried about a dividend cut due to last quarters' results, because LLY has the capital to continue rewarding shareholders even through tough business cycles such as this one. Over the longer term, as new drugs add to Eli Lilly's earnings, dividend increases should become a bigger part of managements' objectives and focus. Investors can stick with LLY and feel confident about the strength of the dividend and the promise of a pipeline to bring success back to the company.

Quest Diagnostics

Quest Diagnostics is a healthcare information and testing company that provides molecular, disease based, and genetic testing to help doctors and patients make better decisions about their healthcare. The more doctors and hospital centers use Quest's services, the more the company brings to the top and bottom line. The company currently has a hold on 12% of the health and wellness market, and added to this hold with the acquisition of Summit health, a leading provider of on-site prevention and wellness services. This addition to the Quest Diagnostics network should boost its relationship with doctors across the nation, as well as be accretive to earnings in the future. Quest Diagnostics also benefits from an underlying long term secular trend - population growth in the United States, as well as the ever- increasing of America's average life span. The more people there are and the longer they need medical assistance, the more Quest's services will be relied upon.

The real value of DGX, however, lies in its dividend. Currently, the company's yield of 2.4%, while not trivial, is not enough to attract the investor looking for outsized dividend returns. However, when researching deeper into DGX's financials, it becomes clear that dividend investors can go with this name and have long term success with regards to the payout. Quest Diagnostics currently pays out only 32% of its earnings in the form of dividends, which means the company could financially manage a dividend increase of 3x and still have earnings left over to contribute to its business. This is assuming no earnings growth in the future, which is unlikely given the company's increasing share of the healthcare service market. DGX has also been raising their dividend fiercely in the recent past - they have more than tripled it since 2012. If this pattern continues, Quest Diagnostics would sport a yield north of 3% in the very near future. Investors looking for dividends can buy into this name now and be ahead of the curve when others come following DGX's impressive dividend increases expected to come in the future.

Conclusion

When an investor looking for dividends researches the XLV, its paltry yield of 1.48% doesn't cause much excitement. However, when looking at the components that make up this ETF, companies exist in the industry that give the dividend chaser exactly what they're looking for - a safe, bountiful and growing dividend, as well as expectation for growth through business activity. A portfolio equally invested in the 4 names above would yield around 3.1%, giving a substantial amount of income while the businesses grow. Given these companies past growth histories, one can expect this portfolio to yield 3.4% next year if each stock is held for that time period, a significant increase when looking at these names from a long term perspective. This, combined with price appreciation of each of the stocks, is able to give investors a better long term return than can be expected from the ETF holding the same names.

Source: Don't Want The XLV? Try These 4 Stocks Instead