The share price of Pfizer (PFE) has risen significantly by 40% over the past 12 months and just made its 52-week high at $30.88. Although I believe the stock still represents a solid long-term investment, I am of the view that buyers should wait for a lower entry price based on the following 5 reasons:
1. Pfizer shares are fully priced based on the company's financial performance relative to that of Merck (MRK), the firm's closest industry peer. According to the chart shown below, both companies' growth potential appears to be fairly comparable. On the profit side, Pfizer does a better job as the firm's various margins and capital return metrics are above Merck's levels. In terms of debt and liquidity, Pfizer carries a slightly higher debt load, but the company is able to maintain a higher free cash flow margin. Both firms' interest coverage ratios are fairly in line. Pfizer has higher current and quick ratios, reflecting a healthy balance sheet condition.
Pfizer's current price multiples at 8.3x forward EBITDA and 13.5x forward EPS (next 12 months) are on average about 10% above the same trading multiples of Merck. Given the comparable growth profile as well as Pfizer's better profitability, Pfizer's modest valuation premium is completely reasonable and fully reflective of the company's strength over its peer on a relative basis (see chart above).
2. Pfizer's forward P/E ratio has increased drastically by 40% over the last 12 months, and it is now trading at only a 9.6% discount to the same multiple of S&P 500 Index (see chart below).
In my view, a larger market discount is likely warranted provided that 1) Pfizer's market discount was averaged at 17.3% in the past 12 months; 2) Pfizer's consensus revenue, EBITDA, and EPS estimates for 2013 and 2014 have experienced multiple downward revisions over the period (see charts below); and 3) the company's 5-year earnings growth estimate at 3.9% is considerably below the average estimate of 8.2% for the S&P 500 companies.
3. The stock's trailing P/E multiple has achieved its 5-year high (see chart below).
From a historical valuation standpoint, the current level is difficult to be justified given the following:
1) Over the past 5 years, Pfizer's ROE, ROA, and ROIC metrics have all experienced a downward trend (see chart below);
2) Pfizer's profitability margins remained almost flat throughout the last 5 years (see chart below); and
3) The company's revenue, EBITDA, and EPS growth rates have also demonstrates a somewhat flat trend despite the significant volatility experienced in 2011, and market's consensus growth expectations are also fairly in line with the historical averages (see chart below).
4. Pfizer's dividend yield has dropped to its 3-year low (see chart below). Given that the current yield at 3.1% is markedly below the 3-year average at 4.1%, the stock would be less attractive to institutional income investors, resulting in less effective downside support by the dividend yield.
5. Sell-side analysts are still bullish on Pfizer. Of the total 21 ratings compiled by Thomson One, there are 8 strong buy and 8 buy ratings. However, even with the bullishness, sell-side's 1-year price target of $30.46 is exceeded by the current share price at $30.67. Given that Pfizer's cost of equity should be approximately within 7% and 8% based on the capital asset pricing model, Street's 1-year price target implies that the stock is overvalued by the cost of equity amount, which is quite material.
Bottom line, Pfizer's price uptrend has resulted in an overbought situation as the share valuation has deviated from the company fundamentals. Given that the overvaluation is not very substantial and the stock's dividend yield remains above the S&P 500 average, current shareholder should continue to hold. For buyers, it would be wise to wait for a correction before pulling the trigger.
All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the charts and the article is sourced from S&P Capital IQ unless otherwise specified.