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With what looks like a rocky summer ahead of us, you might be searching for dividend paying stocks in defensive sectors, such as healthcare. Investors have been favoring healthcare stocks so far in 2011, sending the sector up nearly 14% year-to-date. The problem for income investors, though, is that the healthcare stocks that have performed the best don't pay dividends - indeed there are only 5 dividend stocks in the top 100 performing healthcare stocks year-to-date, and those 5 have low dividend yields of around 1% +/-.

We wondered if there are any undervalued dividend stocks that institutional investors have been buying, and we came up with one: Psychemedics, (NASDAQ:PMD), a micro-cap, drug-testing firm, with a dividend yield approaching 5%. PMD is listed in the healthcare section of our High Dividend Stocks By Sector Tables.

Psychemedics was established in 1987 to provide testing for drugs of abuse using hair analysis and has been successfully operating for over 20 years. Psychemedics has obtained FDA clearance on all drug categories and is the only lab to have clearance not limited to head hair (including head and body hair clearances). (Source: PMD website.)

Here's a market cap & dividend breakdown for PMD, and its 3 major competitors:

click to enlarge

Of these 4 firms, PMD is the purest play on drug testing, where it enjoys the leading market share. The May dividend was their 59th consecutive quarterly dividend.

Institutional investors have favored PMD over its peers, and the current short ratio is also nearly zero.

Even with institutional buying evident, PMD is also currently oversold, with a low stochastic reading of under 20, and a Relative Strength Index of only 33.54.

To be sure, PMD is the runt of the litter, with only a $51 million market cap vs. these other firms, but look at how it stacks up in efficiency and profitability, in addition to being debt-free:

Valuations:

PMD struggled during the recession, which accounts for its poor past 5 Year EPS figures. However, they've turned in positive earnings surprises in 3 of the last 4 quarters, and they look undervalued, with a 12 month PEG of only .59, due to their strong growth forecast.

PMD doesn't have options, so there are no covered calls or cash secured puts trades available.

Source: Psychemedics: An Undervalued Healthcare Dividend Stock With Growth Potential