By Brian Tracz
With a large number of macro concerns that could harm the market as a whole, we are in something of a stock picker's paradise. Richly-valued U.S. equities are presently staring a "fiscal cliff" in the face--an unpleasant basket of spending cuts and tax increases that will be enacted if Congress does not propose its own. The mere possibility of falling off of this cliff is sure to depress the market as we head closer to December.
So where should the intelligent investor place her money? We think that insider activity and hedge fund purchases can give investors a very good indication. In addition high and consistent dividends and large market caps have excellent characteristics to combat a volatile market.
A number of pharmaceutical companies have these characteristics. According to our proprietary database, Pfizer Inc. (PFE) is one of the top ten most popular large-cap stocks among hedge funds. Of the hedge funds we track, as of June 30, 75 had positions in this pharmaceutical giant famous for its blockbuster drugs, which include Lipitor, Celebrex, and Prevnar/Prevnar 13 vaccines (view the hedge funds that hold Pfizer here). Pfizer reported its third-quarter earnings of $0.53 per share at the end of October, meeting analyst estimates despite the loss of sales exclusivity for Lipitor.
Though this less-than-wonderful earnings report depressed shares as the market went up, Pfizer's depressed earnings are not here to stay. First, the exclusivity expirations for Pfizer will reach their peak in 2012, and are unlikely to return to such levels for over three years, according to management. Pfizer's reorganization includes an IPO offering of 20 percent of its animal health business, Zoetis, and the sale of its nutrition unit for $11.8 billion to Nestle SA (OTCPK:NSRGY), pending finalization procedures. The company's historically consistent drug pipeline is also reassuring: the company had 95 drugs in clinical trials at the end of 2011. Though this comes with its standard share of risks, we think that its 3.5 percent annual dividend yield compensates investors well for this risk. Billionaire Ken Fisher, CEO of Fisher Asset Management, seems to agree, holding 1.8 percent of his portfolio in Pfizer.
But Pfizer is not the only pipeline/dividend story in big pharma. Merck & Co., Inc. (MRK) reported its earnings on October 26, beating analyst earnings estimates by $0.03 per share. The company's sales of the popular asthma medication Singulair, fell 55 percent, and the company's total revenue dropped 4 percent. However, Tony Butler of Barclays Capital calls Merck an "emerging pipeline story." A number of drugs currently under development will improve Merck's top line long-term, but it might be a while before we see it reflected in the company's shares, which are trading at some of their highest levels in the past 5 years. Cholesterol medications, notes Butler, could be particularly lucrative once they find their way to consumers. And, like Pfizer, Merck has an attractive 3.6 percent annual dividend yield.
How do the valuations of these two compare? According to price/sales-one of the best metrics for pharmaceutical companies-it's a photo-finish, with shares of Pfizer and Merck trading at 2.8 and 2.9 times sales, respectively. This means that both companies are valued roughly the same according to top-line revenue. However, Pfizer's consensus forward P/E of 10.5 looks cheap compared to Merck's P/E of 12.5. Note also that, though it is trading at about the same according to price/sales, Bristol Myers Squibb Co. (BMY) has a forward P/E of about 18, significantly pricier than both Pfizer and Merck.
At the end, we think the valuation story and the catalyst story together put Pfizer Inc. at the top of the pharma list. As detailed by one commentator, Pfizer's restructuring, price depression, and product pipeline make it a compelling choice. In the face of a potential fiscal dispute in the United States, we agree.