|
Drug
Stocks Worth Checking
Pharmaceutical giant Pfizer’s recent problems got
me thinking about generic drug makers as an alternative to the big guys.
Unfortunately, my research found that generics were
a bad idea. But, in the process, I discovered other interesting
prospects in the drug field. I’ll give you the details in a minute, but
first some background.
Bad Time for Big Pharmas
Pfizer’s share price took a big hit recently
after it stopped development of a new cholesterol drug because of an
unexpectedly high number of deaths.
The news hit Pfizer’s share price hard because the
patents on its current cholesterol treatment, Lipitor, will expire in
2011. When that happens, generic drug makers will sell drugs with the
same chemical composition for a fraction of the price. That’s a big deal
because Lipitor accounts for around 25 percent of Pfizer’s sales. Pfizer
was relying on its new drug to replace Lipitor as the cholesterol
treatment of choice.
Pfizer’s dilemma spotlights a problem that has been
brewing for some time. When patents on their major products expire, the
big drug makers don’t have enough new products in the pipeline to
replace the lost sales.
That’s why the generic drug sector looked
interesting. The timing seems right.
A Look At Generics
Private health insurance companies are increasingly pressuring
doctors and patients to opt for generics over brand name drugs. With the
change in Congress, pressure will build for Medicare to do the same.
Also, the new Congress may enact laws to speed up the introduction of
competitive generics when drug patents expire.
While there’s no doubt that the volume of generic
drugs sold will soar, the dollar value of the drugs sold, and hence,
profits, won’t grow nearly as fast. The problem is that there is too
much competition.
Making generics doesn’t require much research and
development, and companies around the globe are getting into the game,
creating excess capacity, which translates to lower prices.
So, analysts are only predicting around six percent
revenue growth for the generics industry next year, even though the
number of pills sold will increase much faster. It’s hard to make money
on stocks growing revenues at single-digit rates.
Screen Turned Up Prospects
As part of my research, I developed a screen for finding drug
makers with strong growth prospects. While it didn’t find any generic
stocks worth talking about, my screen did turn up a handful of
interesting non-generic drug makers.
I’ll list those at the end, but first, I’ll
describe my screen so you can use it to find prospects on your own.
I used Reuters free PowerScreener Lite program
because it ‘s the only search program I’ve found that that includes all
drug makers in a single category. Without that feature, you’d have to do
a separate search for large firms, biotechs, generic drug makers, etc.
Find the screener from Reuters homepage (www.investor.reuters.com)
by clicking on
Ideas & Screening and then
PowerScreener Lite. Reuters’ screener looks intimidating, but it’s
easy to use once you get the hang of it. That said, locating the
required screening parameters can be challenging, so I included the
category containing the needed parameter in parenthesis after I describe
each screening factor.
Pinpoint Industry
Start by limiting the field to drug stocks by specifying
selecting Biotechnology & Drugs for Industry Description (Descriptive).
Profitable
It’s always best to rule out unprofitable companies, regardless
of the industry. The Net Profit Margin (net income divided by sales)
will only be a positive number if the company was profitable over the
past 12-months. Require a minimum value of 1for Net Profit Margin
(Profitability Ratios).
Avoid Risky Bets
Stocks trading at low prices are usually cheap because investors
see problems ahead. To reduce risk, many investors avoid stocks trading
below $15 per share. Specify a minimum $15 recent price (Price& Volume).
Similarly, we can learn something from a stock’s
price action. Stock’s that have moved up are in favor with the market,
often for good reason. Conversely, stocks that have dropped may have
problems that our screen didn’t detect. To be on the safe side, require
that passing stocks must have gone up at least 10 percent over the past
52-weeks (Price & Volume).
Most pharmaceutical firms rack up annual sales in
the billions of dollars. Low sales identify startups or otherwise risky
bets. Specify at least $500 million for the last 12-months (TTM) sales
(Other).
Let Analysts Do The Work
Reuters tabulates analysts’ buy/sell recommendations for stocks
using a numerical scale (1= strong buy, 2 = buy, 3 = hold, 4 = sell, 5=
strong sell). While analysts are often wrong, it’s safer to avoid stocks
that analysts are advising selling. Since many market players interpret
an analyst “hold” rating as meaning “sell,” stay in the “buy” range by
specifying a maximum 2.5 consensus analyst rating (Earnings Estimates).
Analysts usually estimate average annual earnings
growth over the next five years for companies that they follow. Most
growth investors look for stocks with at least 15 percent expected
earnings growth. Specify a minimum 15 percent expected long-term growth
rate (Earnings Estimates).
My screen listed eight stocks, but there’s one more
step required.
Check Sales Growth
A company isn’t growing unless its sales are growing. For reasons
unknown, analysts sometimes forecast long-term earnings growth even
though they don’t expect much sales growth. We can’t screen for expected
sales growth, but we can check it manually on Yahoo (finance.yahoo.com).
Start by getting a
price quote
and then select Yahoo’s
Analyst
Estimates Report.
Yahoo shows revenue estimates for the current and
next quarter, as well as for the current and next fiscal years. For each
stock turned up by the screen, confirm that forecast next year’s sales
growth (it’s listed, you don’t have to compute it) is at least 15
percent.
Four Prospects
Adding that check cut my list down to four stocks. U.S. Drug
makers Celgene and Gilead Sciences, and Shire, based in Great Britain.
The fourth, Covance, is a U.S. company providing drug developing
services to drug makers.
As always, the stocks listed by screens are
candidates worth researching, not a buy list.
published 12/10/06 |
