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Barbara Ryan: Will Dividend Tax Hikes Make Drug Stocks Sick?

Three of the top ten dividend paying stocks in the S&P 500 are pharmaceutical stocks; Merck, Pfizer andJohnson and Johnson. Therefore, investors are aptly asking the question, will these stocks take ill as we approach a hefty dividend tax hike next year?

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It is true that the generous yields on pharma stocks have been of great appeal. However, they are not one trick ponies.

Drug companies are cutting costs, and delivering better than expected bottom lines despite the well advertised "patent cliff". Company managements are aggressively returning more of their cash flows to shareholders in the form of rising dividends, and share repurchase. PFE, by way of example has increased its payout ratio from 33% to what should reach 40% by 2013, while MRK and Bristol-Myers Squibb have payout ratios which exceed 50%.

But their charm doesn't end there. The single biggest factor which drives drug stocks are new drugs, or lack thereof. Over the past five years, they didn't have 'em. Over that period, the group underperformed the market, multiples fell, and there was significant consolidation. Pfizer bought Wyeth, and Merck swallowed up Schering-Plough to keep earnings afloat.

But, the industry's pipeline is now improving, with new drugs for arthritis, diabetes, stroke, cancer, and Hepatitis C virus hitting the market.

If rates stay low for the foreseeable future, and the economy remains sluggish globally, tax hike or no tax hike, drug stocks will likely continue to be good medicine for investors.

Disclosures: Ryan does not have any disclosures to report and does not own any of these stocks, and she no longer make recommendations to investors.

Barbara Ryan is the Founder of Barbara Ryan Advisors. Ryan has been a sell-side research analyst covering the Pharmaceutical industry for 30 years. She has worked at Bear Stearns, Prudential, Alex Brown, and most recently was a Managing Director at Deutsche Bank. In 2012, Ryan founded Barbara Ryan Advisors, a pharmaceutical consulting firm providing services to pharma companies, investment banks, and institutional investors. Ryan is widely recognized as an authority on the trends and outlook for the global pharmaceutical industry and has been publishing her analysis throughout her career.