We started our search by focusing on the five major drug companies that recently registered on at least one Reuters Select stock screen. (Click here for an Excel sheet comparing these companies.) We were also mindful of recent market dynamics.
Over the last three months, while NASDAQ has climbed approximately 12 percent and the S&P 500 index has advanced roughly 7 percent, the AMEX Pharmaceutical index has inched higher by just 2 percent and the average price gain of the 25 companies in the major drugs industry was nearly 5 percent.
This led us to filter for pharmaceutical companies that posted better-than-average stock-price gains over both the last three-month and one-month periods, respectively. This shortened our list to only two companies: New Jersey-based Johnson & Johnson (NYSE:JNJ) and Switzerland-domiciled Novartis.
At this point, we wanted to identify the company that had the better growth rate and also was trading at a reasonable valuation. To accomplish this, we focused on the company with the lower PEG ratio.
In calculating the PEG ratio, we first determine the forward price to earnings (P/E) ratio, which is the current stock price divided by the consensus of analyst EPS estimates. These P/E ratios are then divided by the average of analyst estimates for the long-term growth rate in earnings per share (NYSEARCA:EPS). Thus, we combine both valuation and growth characteristics. As indicated below, Novartis has the more-attractive PEG ratios.
Given its relatively appealing valuations based on the PEG ratios, it is not surprising to find that Novartis came to light on the Reuters Select value screen for Relative Value, which requires that companies have a PEG ratio below 2.00.
In its pursuit of identifying relatively attractively priced stocks, the Relative Value screen also requires that a company's P/E, P/Sales, and P/Cash Flow ratios, based on trailing 12-month [TTM] performance, are no higher than 10 percent above the industry norm. As shown below, the company meets these requirements.
To help differentiate between firms that are trading at low valuations because of lackluster performance with those names that are cheaply priced, the screen also requires that a company post EPS growth of at least 25 percent in the TTM span. Although its five-year revenue and EPS growth lags the industry average, its TTM figures are marked improvements and Novartis not only satisfies the requirements of the screen but also ranks among the leaders in the industry.
At the time of publication, Erik Dellith did not own shares of any company mentioned in this article.
Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.