Big pharmaceutical stocks have fallen out of favor, especially among investors seeking high-growth investments. Not only are these firms releasing fewer new blockbuster drugs, but the sector as a whole is seeing the headwinds from efforts to limit health care spending worldwide.

Still, the pharma sector has some phenomenal investment opportunities for dividend investors. Many of the industry giants — Johnson & Johnson (NYSE: JNJ), Bristol Myers Squibb (NYSE: BMY) and Merck (NYSE: MRK), for example — are paying 3-4% dividend yields, with some offering yields as high as 9%.

Of course, yield alone doesn’t make a good investment. It’s also important to consider the company’s financial strength, and history of earnings and dividend growth.  

Here is a look at the five top-yielding pharmaceutical companies and my top picks for investors seeking reliable dividend income.

1. PDL BioPharma Yield: 9%

PDL BioPharma (Nasdaq: PDLI) owns a patented process for creating difficult-to-produce humanized antibodies, and licenses this technology to biotech firms in exchange for royalties. Drug companies are using this technology to develop new treatments for cancer, autoimmune and infectious diseases. Since 2004, PDL’s revenue from royalties has grown 20% a year. PDL improved earnings per share (EPS) 23% to $1.08 during the first nine months of 2012 compared with the year-ago period, and the consensus analyst estimate for annual EPS growth is 14% for the next five years. PDL has paid an annual dividend of 60 cents a share since 2011. Payout is conservative at 43% and the dividend yield is generous at almost 9%.

2. Psychemedics Yield: 5%

Psychemedics (Nasdaq: PMD) is the world’s largest provider of hair tests that detect drug abuse. The company’s clients are corporations and government agencies, including more than 10% of Fortune 500 companies, the largest police forces in the United States and nine Federal Reserve regional banks. Last quarter, Psychemedics launched new tests for detecting cocaine, opiates, PCP, methamphetamine and marijuana from head and body hair. It also expanded its lab capacity to include production on Saturdays. Investments in new technology caused EPS to fall 11% to 51 cents in the first nine months of 2012 compared with a year earlier, but bode well for future growth. Analysts predict 20% EPS gains in 2013. Psychemedics is debt-free and generates industry-leading 22% operating margins. The company has paid 65 dividends 65 quarters in a row and hiked payments 25% last year to an annual rate of 60 cents. Payout is rich at 93%, but is likely sustainable, given the company’s good growth prospects and zero debt.

3. GlaxoSmithKline Yield: 5%

GlaxoSmithKline (NYSE: GSK) is one of the world’s largest pharmaceutical companies and a top holding of Warren Buffett. The company faces patent expirations on several key products, including blockbuster asthma drug Advair, but has been investing in its pipeline, which should support long-term growth prospects. New drugs poised to launch include a weekly treatment for diabetes and a daily bronchodilator for chronic obstructive pulmonary disease. Last year’s $3 billion acquisition of Human Genome Sciences also adds new drug candidates for heart disease and diabetes to the pipeline. In the past decade, Glaxo’s EPS growth has averaged 12% a year, but analysts predict a 20% EPS decline this year due to continuing weakness in Europe and growth slowing to 6% in each of the next five years.  Glaxo has a consistent record for dividend growth, which includes a 6% increase last year. Payout is high at 78% and shares yield about 5%. Debt is high at $28 billion and 250% of equity, but Glaxo has $9.4 billion of cash and healthy cash flow exceeding $7.4 billion a year to service its debt.

4. PetMed Express Yield: 5%

PetMed (Nasdaq: PETS) distributes prescription and nonprescription medicines to pet owners, mainly through online channels. This is a pure play on the $50 billion spent on pet care every year in the United States. The company’s top-line growth has slowed because of competition from other online vendors such as Amazon (Nasdaq: AMZN). But PetMed hopes to re-energize sales by expanding product offerings and advertising, and shifting sales to higher-margin items. Cost-reduction efforts are beginning to pay off, too. EPS improved 3% to 63 cents for the nine months ended Dec. 31, 2012 from the year-ago period. Analysts expect PetMed to deliver 5% growth in each of the next five years. The company has no debt and generates $28.5 million of annualized cash flow, which is more than enough to cover $12 million in dividend payments. PetMed has raised its dividend 50% in three years and shares yield almost 5%. Shareholders were recently rewarded with a special $1 one-time dividend this past December.

5. Abbvie Yield: 4%

Abbvie (NYSE: ABBV) was formed through last year’s spin-off of Abbott’s pharmaceutical business into a new public company. Abbvie owns the world’s top-selling drug, Humira, which is used to treat arthritis. The drug is expected to have generated $10 billion in sales in 2012, which accounts for roughly half of Abbvie’s sales.   A big concern for Abbvie investors is the loss of patent protection on Humira in 2016, but the company is replenishing its pipeline through internal drug development and licensing. For example, Abbvie is considered second only to Gilead Sciences (Nasdaq: GILD) in the strength of its hepatitis C drug franchise. Beginning in 2015, the company expects to launch four major new drugs in rapid succession, each of which is expected to produce at least $4 billion in peak sales. Although Abbvie hasn’t reported financial results as a stand-alone business yet, year-over-year income generated by Abbott’s pharmaceutical business rose 13% in the first nine months of 2012 to $5.6 billion. Analysts target 15% annual earnings growth for Abbvie during the next five years. Abbvie has $7.2 billion of cash and annual cash flow of $6 billion, which provides two-fold coverage of the dividend. The company targets 50% payout and is committed to dividend growth. At present, Abbvie pays a $1.60 annual dividend yielding about 4%.

Risks to Consider: Abbvie and Glaxo rely on new drugs for future growth, but drug development is inherently risky. Companies may spend hundreds of millions of dollars on research and still fail to win FDA approval for a new drug. Glaxo investors should also be aware of currency risk since dividend payments are made in British pounds. However, unlike other foreign countries, the U.K. doesn’t withhold taxes on dividends paid to U.S. residents.   

Action to Take –> My top pick overall is Abbvie. This company has a great balance sheet and cash flow, a strong commitment to growing its dividend and superior growth prospects. Glaxo and Psychemedics are a bit riskier due to their high payout. PDL has a poor record for growing its dividend and PetMed faces increasing challenges from competitors, though the stock is a great play on the ever-increasing pet-care industry in the United States.

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