The big pharmaceutical companies may be doing wonders to help patients in poor health, but they sure aren’t doing much in the way of helping investors create healthy gains. In 2006, it looked like these stocks would finally pull out of their slump. But already in 2007, it appears as if their illness is far from cured. And here’s the incredible part – the bigger the company, the worse the performance.
To be fair, the market didn’t really have the best Q1 either. Even a small miracle today or later this week wouldn’t mean a whole lot as we wind down the calendar quarter. As it stands right now, the S&P 500 is only up by 0.86% year-to-date. We can’t expect these pharma stocks to go like gangbusters in a tepid environment. The problem is, it doesn’t appear as if these stocks even deserve to move higher, even if the market environment were better.
The wrench in the works – and it’s a big one – is simply how these major drug makers still look solid when you take a snapshot of the fundamentals. The average large-cap pharma stock’s current P/E of 16.8 is reasonable, even though this group can and has traded less expensively. Better still, the forward-looking P/E of the average drug manufacturer stock is 13.3 – cheap by anybody’s modern standard.
So why can’t these names get any traction in the marketplace? Perhaps investors are watching the numbers a little more closely than these companies realize.
Things Just Don’t Add Up
In the interest of a complete picture, not all the major drug makers are losing ground in terms of revenues and earnings. Enough are, though, to potentially spoil the whole batch.
Johnson and Johnson (NYSE: JNJ) is a good example of how the numbers just don’t seem to make sense. The current P/E of 16.08 is nice, and the forward-looking P/E of 14.13 is even better. But, the current numbers aren’t suggesting the same progress is in store. The quarterly earnings growth of 3.5% is essentially keeping pace with inflation, while revenue growth of 8.5% isn’t a whole lot prettier. That anticipated 12.1% improvement in the current P/E ratio is going to take a little more than very modest top and bottom line growth.
The Merck & Co. Inc. (NYSE: MRK) message is even more mixed. Based on current stock prices, they’re expecting their 2008 year-end P/E to be 15.67, versus the current P/E of 21.65. Great! But, how in the world is that going to happen when earnings are actually shrinking (year-over-year) by 57%, have fallen the last two calendar years, and have fallen for at least three consecutive quarters? Investors haven’t found an answer either…at least not yet. The stock seems to reflect it.
And if you work your way down the list of pharma stocks, more often than not you’ll find a comparable scenario – the current results don’t quite fit with where the company says they’re going.
If It’s Not One Thing It’s Another
If you’re looking for a little evidence that birds of a feather flock together, just take a look at Pfizer Inc. (NYSE: PFE). The stock is down slightly for the year, and has been falling ever since September – entirely missing the big 2006 year-end rally (a red flag in itself).
The unfortunate piece of the puzzle is this…the stock looks well undervalued, and actually appears to have a legitimate shot at trading at its forward-looking P/E of 10.95. That’s a relatively cheap stock, but not even as cheap as the current P/E of 9.6 (both are well under industry norms).
Obviously the Pfizer company is facing huge problems, right? Well, no - not really. Revenue growth is flat, and even taking out a major one-time boon to the bottom line in fiscal 2006, earnings were still 36% better last year than they were the year before. Even with a flat earnings forecast, the valuation remains surprisingly low.
Yet, even Pfizer can’t draw any real buying interest. If a good company’s stock can’t get traction right now, do the weak ones even have a prayer?
Bottom Line
Most individual investors – and most pros for that matter – tend to have more of a ‘show me’ attitude. As of right now, most pharma accompanies haven’t yet proven they’re going to be able to deliver on their lofty plans. In fact, most of the current numbers show anything but that.
One of the trickiest parts about being an investor is deciding whether or not a stock will trade at what the company thinks it’s worth, or if it’s going to trade at what most of the market thinks it’s going to be worth. In most cases, ‘the market’ is right. It doesn’t appear as if investors think much of the drug-makers right now….and, maybe they’re right.
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