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Wanting to learn the investing style of the Oracle of Omaha himself- Warren Buffett- I read The New Buffettology: The Proven Techniques for Investing Successfully in Changing Markets That Have Made Warren Buffett the World's Most Famous Investor by Mary Buffett and David Clark. My biggest take away from that book was what is called the "Ten Points of Light" that Buffett uses to determine which companies he wants to invest in.

In this article, I gave an analysis of Verizon Wireless (NYSE:VZ) using the Ten Points of Light. As an investor in Verizon, I was very shocked by what I found. Here, I'll conduct an analysis of Pfizer (NYSE:PFE) using the same Ten Points of Light.

So the question I'll answer here is, given the information provided, would Warren Buffett invest in Pfizer? Bear in mind that prior to doing this analysis, I have to knowledge or bias as to what will come of this.

Number 1. The Right Rate of Return on Shareholders' Equity

Over the course of the book, the common denominator that Buffett emphasizes is that the company must have a durable competitive advantage. In examining Pfizer's shareholders' equity, the company has to show a consistently high rate of return on equity- above 12%, which is considered by Buffett to be above average.

Net Income and Shareholders' Equity has been taken from Yahoo! Finance. Given this information, the following calculation of net income divided by shareholders' equity is done:

Year

Net Income

Shareholders' Equity

Return on Equity

2010

$8,257,000,000.00

$87,813,000,000.00

0.094 = 9.4%

2011

$10,009,000,000.00

$82,190,000,000.00

0.122 = 12.2%

2012

$14,570,000,000.00

$81,260,000,000.00

0.179 = 17.9%

Based on what we've seen here, although the data only goes back three years, we see a consistent increase in return on equity that has increased 8.5% between 2010-2012.

Score: 1-0

Number 2. The Safety Net: The Right Rate of Return on Total Capital

According to Investing Answers, the return on total capital is calculated by taking the sum of net income less dividends and dividing that by the sum of debt plus equity. Buffett looks for a consistent high rate of return on total capital as well as equity.

Looking at some more quantitative data, debt was determined as the total current liabilities plus long-term debt.

Year

Net Income - Dividends

Debt + Equity

Return on Total Capital

2010

$14,345,000,000.00

$161,104,000,000.00

0.089 = 8.9%

2011

$3,775,000,000.00

$152,911,000,000.00

0.025 = 2.5%

2012

$21,104,000,000.00

$147,525,000,000.00

0.143 = 14.3%

Between 2010 and 2012, we see that Pfizer has delivered a positive rate of return on total capital. However, it is inconsistent, as you see with a drop in 2011. Although positive, it is still inconsistent.

Score: 1-1

Number 3. The Right Historical Earnings

Buffett looks for companies that produce an annual Earnings Per Share (EPS) that historically shows a strong upward trend. Nasdaq.com provided more historical data for this piece of the analysis.

Year

EPS

Year

EPS

2007

1.17

2010

1.02

2008

1.2

2011

1.27

2009

1.23

2012

1.94

As you see, EPS has grown between 2007 and 2012- with the exception of 2010. While no company is perfect, that also includes their growing EPS metric. If you were to look at this from a definitive black-and-white view, Pfizer fails to meet this standard.

Score: 1-2

Number 4. When Debt Makes Buffett Nervous

The book states that "... companies with a durable competitive advantage typically have long-term debt burdens of fewer than five times current net earnings." Let's first look at the debt-to-equity ratio using the formula of total liabilities divided by shareholders' equity, we see a 2012 debt-to-equity ratio of 1.28, the same as the 2011 debt-to-equity ratio of 1.28, up from the 2010 ratio of 1.22.

If you wanted to look simply at the long term debt versus net income, in 2012 the long term debt was $37,646,000,000 versus net income of $1,457,000,000. The way I'm looking at this is that if all net income were applied to the long term debt, it would take just over 2 ½ years to pay off the debt.

This section in the book did appear to be slightly subjective, so personally, I don't think that this is a too bad and I'm not at all nervous by this.

Score: 2-2

Number 5. The Right Kind of Competitive Product or Service

The book says that you have to ask yourself these questions: "Is the product the kind that stores have to carry to be in business? Would the businesses that carry this kind of product be losing sales if they didn't carry this particular brand-name product?" The idea is to find a company or product that consumers are continuously in need of, not one they buy once in their lifetime.

As everyone knows, Pfizer's competitive products are in the medications they produce. What makes Pfizer competitive compared to other competitors such as Merck (NYSE:MRK) or Sanofi (NYSE:SNY) - among others - is that Pfizer has a continuously growing pipeline of drugs that are being tested. As of August 9th, a total of 76 drugs were in the pipeline that would treat various health conditions affecting cardiovascular & metabolic diseases, inflammation & immunology, neuroscience & pain, oncology, vaccines, and biosimilars and rare diseases (Source: Pfizer Pipeline as of August 9, 2013).

Pfizer also remains competitive by spinning off areas of their business that would allow Pfizer to focus on the key pharmaceutical unit. Immediate examples of this includes selling the childrens' nutritional unit to Nestle (OTCPK:NSRGY) and the spin-off of the animal nutrition unit, Zoetis (NYSE:ZTS).

In the pharmaceutical arena, medications need to be taken regularly. While general antibiotics are enough for a one or two-dosage use, there are other medications that treat more severe illnesses that need to be taken indefinitely. Once Pfizer has gained FDA approval for the mass production and distribution of these medications, as long as the patents are in effect, Pfizer has a clear competitive advantage over the opposition.

Score: 3-2

Number 6. How Organized Labor Can Hurt Your Investment

"Seldom will you find a durable-competitive-advantage company with an organized labor force."

In researching any labor union relationships with Pfizer, I didn't find any. I have found that the International Association of EMTs and Paramedics- an affiliate of the National Association of Government Employees (IAEP/SEIU) did make an endorsement of Pfizer's Lipitor drug in 2008. Whether there was some financial angles there is unclear. However, it appears that the employees of Pfizer do not themselves have a labor union or are members of one.

Score: 4-2

Number 7. Figuring out Whether the Product or Service Can Be Prices to Keep Abreast of Inflation

"...a business with a durable competitive advantage is free to increase the prices of its products right along with inflation, without experiencing a decline in demand. That way its profits remain fat, no matter how inflated the economy goes."

As the manufacturer of pharmaceuticals, Pfizer can price the medications as they see fit. In the pricing structure, retailers such as Wal-Mart (NYSE:WMT), Safeway (NYSE:SWY), Target (NYSE:TGT), and all other retailers will add their own 'cut' to the price of drugs. But at the manufacturing level, Pfizer can raise their prices to keep up with inflation.

Score: 5-2

Number 8. Perceiving the Right Operational Costs

This point considers how retained earnings is used and how much is used to maintain the durable competitive advantage. The idea is to take the amount of retained earnings by a business for a given period of time and measure its effect on the business's earning capacity.

The book gives the following example with H&R Block (NYSE:HRB):

In 1989, H&R Block, a company with a durable competitive advantage, earned $1.16 a share. This means that all the capital the business had accumulated until the end of 1989 produced for its owners $1.16 a share. Between the end of 1989 and the end of 1999, H&R Block paid out in dividends a total of $9.34 a share. So [f]or that ten-year period, H&R Block had retained earnings of $7.80 a share ($17.14 - $9.34 = $7.80) to add to its equity base.

The company's per share earnings increased during this time from $1.16 a share to $2.56 a share. We can attribute the 1989 earnings of $1.16 a [s]hare to all the capital invested and retained in H&R Block up to the end of 1989. We can also argue that the increase in earnings from $1.16 a share in 1989 to $2.56 a share in 2000 was due to H&R Block's durable competitive advantage and management's doing an excellent job of investing the $7.80 a share in earnings that the company retained between 1989 and 1999.

If we subtract the 1989 per share earnings of $1.16 from the 1999 per share earnings of $2.56, the difference is $1.40 a share. Thus we can argue that the $7.80 a share retained between 1989 and 1999 produced $1.40 a share in additional income for 1999, for a total return on 17.9% ($1.40 divided by $7.80 = 17.9%).

So let's work on Pfizer using this process. Let's start with 2010:

In 2010, Pfizer earned $1.02 per share. This means that all capital received until 2010 produced $1.02 per share for its owners. Between the end of 2010 and 2012, the total EPS was $4.23 per share. Of that, $2.46 were paid out in dividends. Therefore, for that three-year period, retained earnings were $1.77 per share ($4.23 - $2.46 = $1.77). Earnings increased during that time from $1.02 to $1.94. By subtracting the 2010 EPS of $1.02 from the 2012 EPS of $1.94, we get $0.92. Therefore the retained earnings of $1.77 between 2010 and 2012 produced $0.92 per share- a 51.97% increase in retained earnings.

Score: 6-2

Number 9. Can the Company Repurchase Shares to the Investors' Advantage?

Buffett likes companies that buy back their shares- citing that with share buybacks comes price appreciation. More importantly, he likes companies that have buybacks regularly instead of occasionally.

At the end of June this year, Pfizer announced a $10B stock buyback, which will be the fourth buyback in almost three years! Vuru listed this data for Pfizer's share buybacks ranging from 2002 to 2011:

Year

Shares Outstanding

Stock Bought Back

2002

6.24B

--

2003

7.29B

-14.34%

2004

7.61B

-4.31%

2005

7.41B

2.74%

2006

7.27B

1.88%

2007

6.94B

4.83%

2008

6.75B

2.80%

2009

7.05B

-4.19%

2010

8.07B

-12.74%

2011

7.87B

2.59%

Without knowing the exact dates of the buyback announcements or actual purchase dates, I can't pin down exactly where the buybacks impacted the price. But here, you can compare these years with the share prices.

PFE Chart
(Click to enlarge)

PFE data by YCharts

Score: 7-2

Number 10. Does the Value Added by Retained Earnings Increase the Market Value of the Company?

Warren believes that if you can purchase a company with a durable competitive advantage at the right price, the retained earnings of the business will continuously increase the underlying value of the business and the market will continuously ratchet up the price of the company's stock.

On December 31, 2010, Pfizer had a book value of $10.95 per share and traded at $17.51. As of the close of business on Friday, September 27, 2013, Pfizer has a book value of $11.86 per share and closed trading at $28.88. This means that the book value has increase by about 7.7% and the share price has appreciated by about 41%! While this may not be the most definitive determination, this gives a good indication that this criteria has been satisfied.

Score: 8-2

Final Thoughts

I want to go back to points number two and three because I feel that though those two criteria have not been met because there was an off year, Pfizer does still continue an uptrend after it stumbles. In a black-and-white world, those two points would not have met the Ten Points of Light that Buffett uses, and he himself may dismiss Pfizer based off of that, but I would've given those two a go.

While this article may draw criticism from various people, whether it be criticisms of my formulas or my interpretation of some of these points, I do encourage any and all people interested in Pfizer to read this book and do their own analysis of Pfizer and see if you come up with an analysis which is far off of mine.

I think if Buffett did in invest in a big pharma stock, he would consider Pfizer. I like Pfizer, and to those who own Pfizer I'll venture to guess that they like Pfizer as well. Thank you!

Source: Pfizer: An Analysis Using Warren Buffett's 10 Points Of Light