The healthcare sector is the third-largest sector allocation in the S&P 500, trailing technology and consumer discretionary.
With a weight of nearly 13% in the benchmark U.S. equity gauge, healthcare is undoubtedly significant from an investment perspective, but there’s another reason that many investors love the sector: dependable, steadily rising dividends.
Not surprisingly, the primary driver of healthcare sector dividends is blue-chip pharmaceuticals stocks, such as Dow components Merck (NYSE:MRK) and Johnson & Johnson (NYSE:JNJ). However, some mature biotech companies are dividend payers, and there are payouts to be had in an array of other healthcare industries.
“When you think about dividends within healthcare, most of the dividends are going to be coming from biopharma,” says Morningstar analyst Damien Conover. “A lot of these dividends are very secure, and we anticipate the large-cap pharmaceutical stocks to be very secure in their payments going forward.”
Among the reasons that pharmaceutical companies are able to deliver dependable payouts and a steady stream of dividend growth are wide competitive moats and deep product portfolios that enable these firms to endure patent cliffs and generic competition.
“It really ties back to that economic moat that we were just talking about, this concept of having a portfolio of drugs that really enables strong cash flows and really more predictability than what you would normally think around drug companies,” adds Conover.
There are other dividend advantages with healthcare stocks. For example, the government is unlikely to interfere with these payouts as the Federal Reserve has done with financial services dividends. Second, healthcare is classified as a defensive sector, indicating that a company like Merck or J&J can withstand economic uncertainty and still deliver and grow payouts.
Other sources of allure include the points that some sturdy dividend payers in the healthcare space are currently undervalued and plenty have the financial resources and robust balance sheets to grow payouts without having to fund that growth with debt.
“One, I think a lot of these stocks look undervalued. So, you have some capital appreciation there. And then, two, bringing it back to the dividend: I think the dividend growth for these firms is going to track pretty close to earnings growth,” concludes Conover. “So, I think the dividend payout ratio is probably going to stay pretty static, close to that 50% that the industry on average is paying out. But I think as earnings grow, the dividends will probably grow along with it. So, as an investor, you should be really looking for capital appreciation and dividend yield.”
The SmartETFs Dividend Builder ETF (DIVS) is a solid idea for investors looking for healthcare dividends mixed with other sectors. That ETF devotes 12% of its weight to pharmaceuticals equities.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.