To identify high-quality dividend-growth stocks for this series, I use my Quality Snapshot (QS) grading system.
The system employs quality ratings from five sources that I have come to trust and respect.
- Safety and Financial Strength grades from Value Line
- S&P’s Credit rating
- Morningstar’s Moat rating
- Simply Safe Dividends’ Dividend Safety grade.
I assign 0 to 5 points to each factor according to the following table.
After assigning points for each factor, the Quality Snapshot score for a company is the total of its points. The highest possible score is 25 (5 points x 5 factors).
This is how I interpret the scores.
The top two (green) categories are where I like to find most of the stocks that I invest in, and such are the only companies that I present in this series of articles.
High Quality Dividend-Growth Stock for June, 2021: Gilead Sciences (GILD)
Gilead Sciences (GILD) was founded in 1987, is headquartered in Foster City, CA, and went public in 1992. It had a period of breakneck growth in the early 2000’s, which led to five stock splits between 2001 and 2012. It paid its first dividend in 2015 and has raised its payout each year since then.
Gilead’s core activities focus on the prevention, treatment, and cure of life-threatening diseases. The company develops and markets therapies in HIV, hepatitis B and C, pulmonary and cardiovascular diseases, and cancer.
Gilead has pioneered more than 25 products since its founding, including the first single tablet regimen to treat HIV and the first medicine to prevent HIV. At one point, it delivered four curative hepatitis C therapies in less than four years.
Gilead’s deep antiviral knowledge helped it rapidly advance and deliver Veklury (Remdesivir), the first treatment for COVID-19 approved by the FDA, which has been administered to about half the Covid-19 patients in US hospitals.
In 2020, Gilead significantly enhanced it oncology portfolio. It entered into 11 acquisitions and partnerships in oncology, adding to both its commercial portfolio and developmental pipeline. The company has set a strategic ambition of delivering 10+ transformative medicines to oncology patients by 2030.
Most of Gilead’s sales come from the USA (74%), with a significant portion also coming from Europe (16%).
(Source: Gilead 2020 annual report)
As with all brand-drug companies, Gilead faces patent expirations on its products, so it is constantly trying to create new ones. Recent expirations on its hepatitis drugs and HIV treatment Keytruda have caused its revenue to decline since peaking in 2015.
(Source: Simply Safe Dividends)
Projecting Gilead’s revenue has inherent uncertainty that proceeds from difficulty in projecting the long-term market viability of Veklury, since demand for it largely depends on the course of Covid-19. Veklury made up about 20% of 2020’s revenue.
At its Q1 earnings announcement, Gilead said that Covid-19 is expected to continue to impact its business with respect to Veklury and also broader areas such as hepatitis treatment initiations and HIV new starts and switches. The company expects a more gradual recovery in the COVID-19-related dynamics starting in Q2 2021. Sales of Veklury will continue to be subject to significant volatility and uncertainty.
Gilead guided to full-year product sales, excluding Veklury, of about $22 B, with Veklury adding an additional $2-3 B. That would keep its 2021 sales basically flat compared to 2020.
Gilead has high margins, which lead to strong cash production.
Gilead’s operating margin is higher than companies such as Merck (MRK), AbbVie (ABBV), Pfizer (PFE), and Amgen (AMGN). It is this strong cash production that supports Gilead’s dividend.
Gilead has a strong pipeline of drugs in development.
(Source: Gilead Q1 2021 earnings presentation)
The company has high expectations for oncology drug Trodelvy, which is just entering the market commercially, and for which the company is seeking expanded indications in breast cancer, bladder cancer, and advanced urothelial cancer. Trodelvy has blockbuster potential; Morningstar estimates it may generate $5B annually by 2030.
Gilead’s High Quality
Here is how Gilead Sciences stacks up on the Quality Snapshot system described at the beginning of this article.
Gilead gets green ratings on three of the five factors and yellow ratings on the other two. It totals 19 points out of 25, which is above average.
Morningstar’s Wide moat (its highest ranking) is based on Gilead’s patent protections, leading market share, and outstanding profitability in HIV treatments, along with continued dominance in the hepatitis C market.
Those strengths are backed up by Gilead’s expertise in infectious diseases and single-pill formulations. Morningstar see those factors leading to strong returns for the next two decades, as Gilead translates its strengths to broader infectious disease markets.
Gilead’s Dividend Record
I give Gilead an overall grade of B for its dividend record.
As a relatively new dividend payer and raiser, Gilead cannot score high on its increase streak. That’s not its fault, as it just started paying dividends. But, that said, the company has not yet demonstrated an elite, decades-long commitment to its dividend in the way that a Johnson & Johnson (JNJ) has with its 58-year streak.
Gilead has compiled a record not unlike that of many other relatively young dividend companies: It began paying and raising its dividend a little over 20 years after it went public, has grown it quickly for a few years, and now is slowing down the growth as it reaches the “right level” of dividend payout for its business.
That makes it difficult to predict what Gilead’s “average” annual increase will turn out to be. It probably won’t be as high as its 5-year average DGR of 16% per year, but it may not be as low as its most recent 4.4% increase either.
The favorable tradeoff for that uncertainty is that Gilead is available at a 4%+ yield. Assuming that Gilead does not cut its dividend in the future, an investor’s yield on cost (YOC) will never be less than their initial yield.
Gilead highlighted its dividend at its recent Q1 2021 earnings presentation.
That slide highlights not only the company’s commitment to the dividend, but also to share repurchases, paying down debt, and continuing investment in R&D and the company’s pipeline.
To value a stock, I use four valuation models, then average them. For more details, see Dividend Growth Investing Lesson 11: Valuation.
Models 1 and 2: FASTGraphs P/E Benchmarks
FASTGraphs present a stock’s price on the same chart as valuation reference lines for easy comparison. I use two reference lines on the graphs to denote fair value.
- A magenta line based on a standard P/E ratio for “the market” that I set at 18 for most stocks. That reflects average market P/Es over the past 20-30 years.
- A blue reference line based on the stock’s own P/E ratio for the past 5 years. For Gilead, that 5-year average P/E has been 8.4.
Here is the FASTGraph for Gilead using an 8-year display period. I use the 8-year display because it causes FASTGraphs to use the stock’s 5-year average P/E for the blue line, which is the benchmark that I want.
The black line is Gilead’s actual market price. It sits at a current P/E of 9.5.
To quantify valuation using these models, I create valuation ratios via this formula:
Valuation ratio = (Stock’s Current P/E) / (Reference P/E).
Valuation ratio #1 (magenta line) = 9.5 / 18 = 0.53
Valuation ratio #2 (blue line) = 9.5 / 8.4 = 1.13
The first model suggests that Gilead is extremely undervalued, while the second model suggests that it is overvalued. The first model’s numerical result seems extreme, so I put a floor under it of 0.80. I do that occasionally when a model seems like too much of an outlier.
Model 3: Morningstar’s Discounted Cash Flow
Morningstar takes a different approach to valuation. They ignore P/E and other common valuation ratios.
Instead, they use a discounted cash flow (DCF) model. That means that they discount all of the stock’s estimated future cash flows back to the present to arrive at a fair value estimate. The idea is that a stock’s fair price is equal to the net present value of all of the company’s future cash flows. I believe that Morningstar does a sound, conservative job of making projections to use in its calculations.
Here is Morningstar’s valuation of Gilead.
Morningstar finds Gilead to be undervalued, selling at a 17% discount, with a valuation ratio of 0.83.
Model 4: Current Yield vs. Historical Yield
The final model compares the stock’s current yield to its historical yield.
If a stock is yielding more than its historical average, that suggests that it is a better value than usual, because you are paying less for the stock’s dividends.
We can see the yield comparison on this graph from Simply Safe Dividends. Gilead is currently yielding 4.2%, which is more than its 5-year average (3.4%).
Again with this model, we make a valuation ratio.
Valuation ratio = 3.4% / 4.2% = 0.81
To arrive at my overall valuation, I average the four models.
I conclude that Gilead is 11% undervalued.
From there, it is easy to calculate a fair price; just divide the current price by the valuation ratio. Gilead’s recent price is about $67. So we get $67 / 0.89 = $75 for Gilead’s fair price.
All valuations are estimates about the future. Therefore, it is logical to think in ranges rather than precise values. I regard any price within +/- 10% of my calculated fair price to be “fair.”
If I apply that 10% cushion to Gilead, that puts the top of its buying range at $83.
Obviously, with Gilead currently trading so far below its fair price, there is no need to even think about its maximum buy price. A good time to buy Gilead is right now, at a 17% discount.
Gilead is a high-quality company trading at a significant discount. The discount leads to its current yield being quite a bit higher than usual, at 4.2%.
Its dividend is considered safe, based on Gilead’s high profit margins, excellent cashflow generation, and relatively low payout ratio.
The tradeoff for Gilead’s high yield is uncertainty around its earnings continuity. Its business has been disrupted somewhat, in both good and bad ways, by Covid-19. The pandemic has aided Gilead by greatly increasing demand for Remdesivir, which is used to treat Covid patients. On the downside, the pandemic has interrupted many doctor-patient relationships, which in turn has reduced demand for some of its other products.
Additional uncertainty comes from patent cliffs, which is offset to a certain extent by the potential of drugs in the company’s pipeline, particularly Trodelvy, which is off to a strong start and has blockbuster potential as it gains approvals for new uses.
CFRA polls analysts on their recommendations about stocks. 31 analysts are covering Gilead, and the average of their recommendations lies between Buy and Hold.
Jason Fieber made Gilead his Undervalued Dividend Growth Stock of the Week: Gilead Sciences (GILD) a few weeks ago.
I consider Gilead to be one of several potential stocks that I might buy when I replace AT&T in my Dividend Growth Portfolio later this year. See this article for my strategy with AT&T: Dividend Growth Stock of the Month for June 2021 – Special Edition on AT&T (T).
This article is not a recommendation to buy, sell, hold, trim, or add to Gilead. As always, perform your own due diligence. Check the company’s complete dividend record, business model, financial situation, and prospects for the future. Also consider your tolerance for risk, and especially consider how well the company fits your long-term investing goals.
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