Saving the world from Covid-19 doesn’t seem to count for much on Wall Street.
The global drug industry mobilized quickly to tackle the pandemic, and the results have been remarkable, with the rapid development of effective vaccines by companies like
(ticker: PFE) and
Johnson & Johnson
Investors haven’t been in a celebratory mood, however. Most major U.S. drug stocks have badly trailed the overall market in the past year—the
VanEck Vectors Pharmaceutical
exchange-traded fund (PPH) is up 21%, compared with a 43% rise in the
Instead, investors have gravitated toward companies that stand to more directly benefit from a return to normal life and a reopening of the economy in the U.S. in the months to come.
As a result, drug stocks now look like one of the best pockets of value in a richly priced stock market. Major pharmaceutical companies trade for an average of 13 times projected 2021 earnings, against a price/earnings ratio of 22 for the S&P 500.
The drug P/E ratio is one of the lowest among any major industry group. Indeed, the stocks haven’t been so inexpensive relative to the S&P 500 in at least 20 years, according to J.P. Morgan analyst Chris Schott. Most yield 3% or more—double the 1.5% yield on the S&P 500—with Pfizer at 4.4% and
(ABBV) at 4.8%.
“It’s hard to believe the drug stocks are so cheap,” says Jon Boyar of the Boyar Value Group “The companies have built up so much goodwill.”
Bill Smead, manager of the Smead Value fund, which holds
(AMGN), and Pfizer, argues that the group amounts to a “closet reopening play.” Many Americans put off going to the doctor in 2020 and didn’t get prescriptions for chronic conditions like osteoporosis, which hurt revenue. Merck has estimated that Covid-19 depressed sales by about 5% last year.
So, growth is coming. Schott says that the major drugmakers could average mid-single digit annual revenue growth and low-double digit earnings growth through 2025. That should stack up well versus most industries.
“There’s no reason to avoid the group,” he says. “We’re seeing drug pipelines strengthening, and core operations generally are exceeding expectations.”
One investor who is keen on drugmakers is
CEO Warren Buffett. In the second half of last year, Berkshire (BRK.A, BRK.B) bought stakes of about $2 billion each in three drug stocks: AbbVie,
Bristol Myers Squibb
(BMY), and Merck.
Sources: Bloomberg; Mizuho Securities; J.P. Morgan
The investment highlights Buffett’s value investing philosophy. The three stocks have some of the lowest P/E multiples in the pharmaceutical group. Investors can now buy Merck for below Buffett’s cost and Bristol Myers for about what he paid.
The drugmakers, Smead says, “are wonderful businesses,” echoing a Buffett phrase. “These companies have fantastic balances sheets, massive free cash flow, sustainable profit margins, and high returns on equity without using leverage,” he says. They’re socially responsible and have great governance.”
However, as with the language about potential side effects that accompany every drug commercial, there are a number of investing risks to be noted.
Most drugmakers are facing patent expirations on their top-selling drugs this decade. J.P. Morgan’s Schott, however, says the patent issue looks manageable, given a promising industry drug pipeline that is focused on oncology, immunology, diabetes, and Alzheimer’s disease.
“This is a totally different situation from the last time the sector was at a similar relative valuation,” in 2011 and 2012, Schott says. “Then, you had a more severe patent cliff and no pipeline to speak of.”
Another investor fear is the…