Allergan (AGN) is as sound company with a lot of great things going for it. The firm has great financials, an economic moat, a sound product pipeline, good growth prospects and history of strong revenue growth. So why not like the firm then you ask? In our view, the firm is simply overpriced from a valuation standpoint. Often one of the toughest things to do is walk away (not buy) from a great company like Allergan but today that's the situation we see.
By all means, investors should normally be pouring into this stock at much lower levels and if anyone did over the last couple years, they made the right move. Further, that's not to say the stock can't go higher or that it won't but remember all boats rise with the tide. For us to be bullish on Allergan, we would need to be extremely confident the stock is going to double in the next year or two to justify buying it with this rich of a price tag. Right now that isn't the case. Currently, we rate Allergan a PASS because of a few key price multiples and think this name should instead be put on a watch list because of certain strengths the firm holds.
Pricing To the Moon:
When we first decided to look at Allergan we were pretty excited and definitely learned some surprising facts but not the one's most investors want to see. As well, we compared AGN's numbers not only to the industry average but the S&P 500 (SPY) to give multiple perspectives and to provide a better picture of the situation. Given the firm's current valuation one could almost mistake it for some speculative company that provides daily flights to the moon but unfortunately this isn't the case.
Looking first at AGN's Price/ Sales ratio we see that it comes out at 5.0. That means investors are paying $5 for every $1 of sales that AGN generates. If this sounds appealing we're also selling some US landmarks at very affordable prices. Just kidding. Now the industry P/S ratio and S&P 500 P/S ratio listed far below AGN's number at 2.7 and 1.4 respectively. Anyone who says that this is a justifiable price multiple for AGN and thinks the stock is a cheap buy today probably has a pretty big bias towards the firm already.
Forward P/E Ratio:
Given the high P/S ratio we decided to check out how investors were pricing the firm in relation to future earnings by looking at the forward PE ratio. Again, it was another huge number relative to the industry average and S&P 500 index. The forward PE ratio for AGN came in at 19.4. Put that number against the S&P 500's 13.9 forward PE ratio and we see that there is more value in buying an index over this name.
We often look at the Price/CFO ratio because we care more about how much cash flow the firm is actually receiving than how much it's booking in sales. Well the number came in at a wild 58.5. The industry average on the other hand stood at just 10.1 and the S&P500 stood at 9.7. This price multiple is so high we see it as the equivalent to someone running a care on premium gas but then also throwing crushed up diamonds in the tank with the belief that it will make a car run better. Even an amazing firm like Apple (AAPL), which often commands a price multiple premium, only has a Price/CFO ratio of 11.7. We would prefer to put our money on Apple over Allergan any day with a price multiple valuation like this.
It's tough to not like a firm that has grown revenue by 11.71% on average over the last 10 years and also has a five-year growth forecast of 14.9%. The firm even has $2.7B in cash, no net debt and quick ratio of 1.72, which only makes it more appealing. Still, despite all these positive facts that doesn't change the fact that the firm is just pricing way too high from a valuation standpoint. Even though Allergan is a great company that doesn't make it a great BUY.
We do like growth and value companies but we like to buy them when they are trading at favorable prices. In our opinion AGN's currents price isn't favorable to any investor looking to buy a new name, that is why rate it a PASS and why we think this name should be put on the watch list given all the firm's strengths.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.