That is not to say, however, that I shun large cap stocks all the time. If a bigger company has fallen upon hard times and is being beaten up by Wall Street, it often represents an excellent opportunity for a contrarian investment. Expanding on this theme, shares of Amgen (AMGN), the largest biotechnology company in the world, have been slammed in recent weeks and the stock is trading at valuations not seen in years, if ever.
The tables have turned very quickly on Amgen shareholders. The stock hit a new yearly high in January of $78 per share. Since then though, they have seen a 25% haircut on several negative news events.
First, the FDA ordered the company to alter its warning label on Amgen's lead products for Anemia, Aronesp and Epogen, in order to warn doctors and patients about increased risks when using the drugs for off-label uses. Investors are worried that Amgen could lose as much as 10% of their sales of these drugs if people currently using them in off-label doses cut back.
There are also concerns about Amgen's product pipeline, which many view as weaker than some other large cap biotechnology stocks. In fact, the company announced just last week that they stopped a clinical trial for one of their cancer drug candidates that they were testing in combination with Genentech's Avastin and chemotherapy.
Despite the short-term setbacks for the company, Wall Street's current valuation seems to be pricing in all of the negatives, giving very little chance that Amgen will be able to continue to grow. With the stock down $20 from its recent highs made earlier this year, the stock now trades at an astounding 14.9 times trailing earnings, cheaper than the S&P 500. As you can see from the chart below, biotech stocks traditionally trade at a premium to the market, and today is no exception, except for Amgen.
The current stock price seems to suggest that Amgen not only will lose a sizable chunk of Anemia franchise sales, but also will not be able to make that up with any new drugs. Although that seems to be very unlikely over the long term, even if we assume the company does not grow, and their profits level out at around their 2006 level of $3.90 per share, the stock seems to have little downside. This is not to say it can't go lower in the next few weeks or months, but long term, I really can't see a world-class biotech company like Amgen trade at much less than 14-15 times earnings.
Obviously, a huge downward revision in earnings forecasts would make the current P/E outdated, but with a strong stock buyback in place, and the ability to make acquisitions to fill up their product pipeline (they bought Abgenix last year), an earnings collapse seems unlikely. Growth may slow, but the stock already reflects much, if not all, of that expectation.
If anything positive happens with the company, investors will likely realize fairly quickly that they became way too negative. With 25 drugs currently in development, the days of successful discoveries in Amgen's laboratories shouldn't be over by any means, but judging by the stock price, you'd think the company was on life support.
In cases like this when the market is assuming the worst, oftentimes it turns out that things will play out better than people are fearing. In my opinion, contrarian investors should consider adding Amgen to their list of stocks that warrant a closer look.
Full Disclosure: Author is long AMGN at time of writing.