Back in March, I wrote that Pfizer (NYSE:PFE) was a good value opportunity since it was trading “well below its historical valuation parameters.” At the time, I estimated that it was worth $42.39. Since then, PFE stock has risen from about $35 to around $39.
I now think PFE stock could have significantly more upside if its dividend yield falls. This is based on the fact that the yield will likely fall if the company returns to doing buybacks.
So, here’s what you should know about Pfizer stock moving forward.
PFE Stock: Finding Value Using the Dividend Yield
Much of my previous analysis was based on a historical dividend yield of 3.8% and Pfizer’s annual dividend of $1.56 per share. This is based on a quarterly dividend rate of 39 cents.
I now believe that the yield could fall to below 3.0% and its dividend rate will likely rise to $1.60 on a run-rate basis. This is based on an expected 40 cents per share quarterly dividend rate.
Therefore, this implies that the fair value estimate for PFE stock could be worth as much as $53.33. Here is how I determine this: take $1.60 and divide it by 3.0%. That works out to $53.33.
This shows that PFE stock could easily rise by $14.36, up from its Jun. 3 price of $38.97 to $53.33. This represents a potential gain of nearly 37% for the stock.
Why do I say this? First, Pfizer tends to increase its quarterly dividend by 1 cent per quarter after every four quarters. It has already paid out 39 cents per share for the past two quarters. Its next dividend declaration date will probably be around Jun. 22. After the 39 cent declaration following that, PFE stock will likely start reflecting the expectation of a 40 cent quarterly dividend (i.e., $1.60 per year).
Second, PFE stock now has a dividend yield of 4.0% (i.e., $1.56 / $38.97). This is different from its historical dividend yield average of 3.81% (i.e., sometimes much lower and sometimes much higher), which is noted on Seeking Alpha.
Therefore, even if PFE stock were to trade with its expected higher dividend rate (i.e., $1.60 per share) at its historical average, it would be worth about $42 (i.e., $1.60 / 3.81% = $42).
How Buybacks Will Lower the Dividend Yield
But I suggest that PFE stock could rise in price, to the point where its dividend yield will fall to the level of 3.0%. This is because, if you look at analysts’ projections for earnings over the next several years, you can see that earnings will be very stable and grow just slightly.
However, up until last year, Pfizer was doing a large dollar amount of buybacks. It stopped doing those as the pandemic hit. Now, though, I suspect it may have to return to doing these, given the lackluster growth in earnings per share (EPS). This will tend to push up the stock price and also lower the dividend yield.
For example, in the year ending Mar. 31, Pfizer produced $15.8 billion in cash flow from operations (CFFO) and spent $2.35 billion on capital expenditures. That implies an annual free cash flow (FCF) of $13.45 billion. This is seen from Seeking Alpha’s page on its historical cash flow statements.
This represents a FCF yield of 6.19% on its recent market value of $217.13 billion. But the dividend yield is only 4.0% (see above). This leaves room for 2.19% of its stock (i.e., 6.19% FCF yield minus 4.0% dividend yield) to be bought back. The effect of that will lower the dividend yield to 3.0% and push PFE stock up to $53.33.
What to Do with PFE Stock
Management will really have no choice but to return to doing these buybacks in order to help move PFE stock higher.
For example, the dividend currently costs about $8.5 billion at 39 cents per share each quarter. This leaves $4.95 billion that could be spent on buybacks ($13.45 billion in FCF – $8.5 billion).
Of course, this assumes that none of the difference is used to pay down debt. So, perhaps not all of that amount will be spent on buybacks. But even if just $3 billion is used to buy back stock, it still represents a “buyback yield” of 1.38% (i.e., $3 billion / $217.13 billion market value).
This is how the dividend yield could fall 1 percentage point as I project, from 4.0% to 3.0%. It’s what’s known as the total yield concept, adding together the buyback yield to the dividend yield. It also could create significant upside in PFE stock.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.