6 Buffett-Friendly Pharmaceutical Stocks

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Includes: ABT, BMY, LLY, MRK, PFE, TEVA
by: Stock Croc

Warren Buffett has three pharmaceuticals in his portfolio at the present time. They are Johnson & Johnson (NYSE:JNJ) at 42.65 million shares, SanofiAventis ADS (NYSE:SNY) at 4.064 million shares, and GaxoSmithKline PLC ADS (NYSE:GSK) at 1.511 million shares. Even with Buffett’s money, these represent a substantial investment in the healthcare sector. One can’t help but wonder if Buffett will lead Berkshire Hathaway (NYSE:BRK.A) further into these waters.

To that end, I screened through FINVIZ.com to find likely candidates. Let’s take a look at them and see if you think they pass muster. I’ll certainly let you know what I think.

Eli Lilly & Co. (NYSE:LLY) is a large cap, trading at about $37.41. It has a trailing twelve month price/earnings ratio of 8.95 which would likely please the oracle of Omaha. The price/earnings growth ratio of negative 1.96 would, very likely, wipe the smile from his face. Declining earnings are not likely to please any investor. Moving to price to book, we have a pleasing 2.77. Lilly’s return on equity is an impressive 33.93. Quarterly year over year revenue growth is 8.70 but we are again disappointed with a quarterly year over year earnings growth of -5.10. The current ratio of 1.77 speaks well of Lilly’s financial position.

A cursory review of the balance sheet demonstrates a year-over-year strengthening of the cash position. Moving on to the dividend yield of 5.20%, we see that translates into a 47% payout ratio. I wrapped up the analysis with a review of the income statement and I am pleased to report that year over year net income is in positive territory. These drug makers live by their discoveries and die by expiring patent rights. Consequently, I was pleased to see that Lilly has continually ramped up its research and development investment. On balance, I would add this to my portfolio, but then I’m a bit of a contrarian.

Pfizer Inc. (NYSE:PFE) is a large cap, trading at about $19.84. It has a trailing twelve month price/earnings ratio of 13.78 which is quite acceptable. The price/earnings growth ratio of 2.60 would, very likely, be a deal breaker for Warren Buffett. Moving to price to book, we have a gratifying 1.69. PFE’s return on equity is unimpressive at 11.45. Quarterly year over year revenue growth is 7.50 and quarterly year over year earnings growth is a decidedly impressive 331.60. The current ratio of 2.25 speaks well of Pfizer’s financial position.

A cursory review of the balance sheet reveals a significant decline in inventory which may suggest that management perceives a weakening demand. The dividend yield of 4.00% is supported by a 54% payout ratio. I wrapped up the analysis with a review of the income statement which shows a decline in year over year net income of 4.38%. Funding of research and development was increased for 2010, but year-over-year 2009/2008 was static. The quarterlies look better, and me, I’d take a flyer on this one. Warren probably wouldn’t.

Teva Pharmaceutical Industries Limited (NYSE:TEVA) is a large cap, trading at about $39.80. It has a trailing twelve month price/earnings ratio of 11.85. The price/earnings growth ratio is 0.82, a very good number likely to please any investor. Moving to price to book, we have an equally satisfactory 1.54. Teva’s return on equity is a lukewarm 13.60. Quarterly year over year revenue growth is 2.20 and we are once again disappointed with a quarterly year over year earnings growth of -12.80.

The current ratio of 1.13 suggests limited cash reserves and a quick review of the balance sheet shows the bulk of the company’s assets are inventory and receivables, not good. Moving on to the dividend yield of 2.30%, we see that translates into a 23% payout ratio.

Merck & Co., Inc. (NYSE:MRK) is a large cap, trading at about $35.26. It has a trailing twelve month price/earnings ratio of 25.77. The price/earnings growth ratio of 2.04 doesn’t blow me away. Moving to price to book, we have an acceptable 1.95. Merck’s return on equity is a wimpy 7.52. Quarterly year over year revenue growth is 8.10 and we get a pleasant shock with a 394.70 quarterly year over year revenue growth ratio. The current ratio of 2.07 speaks well of Merck’s financial position.

A cursory review of the balance sheet demonstrates a modest year-over-year strengthening of the cash position. Year over year inventory levels have declined some 27% and accounts receivable seem unusually high. The quarterlies show this trend goes on unabated. Troublesome, but absent an aging, the information is not meaningful. Moving on to the dividend yield of 4.30%, we find it unsupported by a 110% payout ratio.

I wrapped up the analysis with a review of the income statement and although year over year net income is in positive terrain, it is declining substantially. Merck has dramatically increased its research and development investment as it seeks a new drug to turn things around. This one's not for me, not for Warren.

Bristol-Myers Squibb Company (NYSE:BMY) is a large cap, trading at about $32.83. It has a trailing twelve month price/earnings ratio of 16.93. The price/earnings growth ratio of negative 356.75 might cause you to think we should end our analysis, but let’s proceed. Price to book is 3.36. Bristol-Myers’ return on equity is a surprising 30.17. Quarterly year over year revenue growth is 11.40 and quarterly year over year earnings growth is 2.10. The current ratio of 2.03 speaks well of Bristol-Myers’ financial position.

A cursory review of the balance sheet demonstrates the year-over-year cash position to be flat. Moving on, the dividend yield is 4.00%, supported by a 47% payout ratio. Concluding the analysis with a review of the income statement we find the reason for the substantial negative price/earnings growth ratio. It stems from the spin off of Bristol-Myers’ stake Mead Johnson Nutrition Company (NYSE:MJN). At the end of the day, it isn’t a terrible stock, but not up to Buffett’s standards or mine for that matter.

Abbott Laboratories (NYSE:ABT) is a large cap, trading at about $54.31. It has a trailing twelve month price/earnings ratio of 18.73 The price/earnings growth ratio of 1.26 isn’t bad. The price to book is 3.44. Abbott’s’s return on equity is acceptable at 19.71%. Quarterly year over year revenue growth is 13.20 but we are disappointed one more time with a quarterly year over year earnings growth of -66.00. The current ratio of 1.50 is textbook.

A review of the balance sheet demonstrates a year-over-year weakening of the cash position. The dividend yield of 3.50% is supported by a 64% payout ratio. I finished the analysis with a review of the quarterly income statements. Abbott is clearly struggling. Operating expenses soared in the quarter ending September 30th, 2011, driving earnings down from about $2 billion in the previous quarter to just over $300 million. Prospects for Abbott are bright nonetheless as it gears up to spin off its pharmaceutical enterprise. Would this be of interest to Mr. Buffett? I’m not so sure. Does it interest me—you bet!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.