Using Ratios To Identify Stocks Set To Outperform Their Peers: Pharmaceutical Rankings Update

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Includes: ABBV, GILD, JNJ, MRK, PFE
by: Stock Scrutiny
Summary

New scores of pharmaceutical companies contained in my analysis are given for debt, profitability, efficiency, and growth.

Final scores for each company over the last 3 years are presented, using the newly implemented way of accounting for share buybacks.

Different trends that appear from comparison of final scores are analyzed.

Intro

As I begin to collect a 3rd year of data for companies in my analyses, I'm overcome with excitement. Having 3 years of data not only allows me to start analyzing multi-year trends, but gives me a larger amount of data in general, which will help establishing validity for any conclusions I draw from the research. For those who have not read any of my articles before, my goal is to show that companies who display above-average financial strength compared to their competitors (using my system of ratios) will outperform the companies with weaker balance sheets in the long run. The process of how I come to the scores that will be displayed below is explained in detail in this introductory article.

Included in this analysis is Johnson & Johnson (JNJ), Abbvie (ABBV), Merck (MRK), Gilead (GILD), and Pfizer (PFE). Ratios and other metrics were gathered using E*Trade and all historical data was collected from Nasdaq.com.

Debt

JNJ

ABBV

MRK

GILD

PFE

Current Ratio

1.47 (3)

.98 (5)

1.17 (4)

3.38 (1)

1.57 (2)

Quick Ratio

1.20 (3)

.89 (5)

.92 (4)

3.30 (1)

1.33 (2)

Defense Interval

265 (4)

381 (3)

239 (5)

2,263 (1)

611 (2)

Interest Coverage Ratio

19.95 (1)

4.74 (5)

11.57 (2)

7.61 (4)

11.43 (3)

Current Liquidity Ratio

190 (2)

250 (3)

446 (5)

-847 (1)

301 (4)

Debt/Equity Ratio

.51 (1)

-4.77 (5)

.94 (3)

1.28 (4)

.66 (2)

Current Debt Scores

1. Gilead- (1 + 1 + 1 + 4 + 1 + 4) / 6 = 2

2. Johnson & Johnson- (3 + 3 + 4 + 1 + 2 + 1) / 6 = 2.33

3. Pfizer- (2 + 2 + 2 + 3 + 4 + 2) / 6 = 2.5

4. Merck- (4 + 4 + 5 + 2 + 5 + 3) / 6 = 3.83

5. Abbvie- (5 + 5 + 3 + 5 + 3 + 5) / 6 = 4.33

Gilead takes the top spot in regards to debt this year. Coming in a close 2nd, Johnson & Johnson scored a 2.33, with Pfizer right behind it with a 2.5. To get to the 4th place finisher, we have to jump over a full point into the 3's where Merck scored 3.83. In last place was Abbvie, who had a poor showing in this category with a score of 4.33. Here is a look at this group's debt scores over the past three years:

'17 Debt Score '18 Debt Score '19 Debt Score
Johnson & Johnson 1.5 2.17 2.33
Abbvie 3.67 3.83 4.33
Merck 3.5 3.67 3.83
Gilead 2 1.83 2
Pfizer 4.33 3.33 2.5

Line Graph Showing Trend of Debt Scores

Keep in mind that if a company improves its position among competitors, its score will decrease, not increase.

A few interesting trends appear when looking at the data table and graph above. Some of the more consistent placers in the debt category are Gilead and Merck. For Gilead, this is a good thing, as their low score has put them in 1st place for the last two years. Merck, on the other hand, has a much worse debt score, so this stagnant score represents an inability to make up any ground on its competitors in regards of debt. There was also two cases where a stock's score had clearly worsened their position over time: Johnson & Johnson and Abbvie. Abbvie already had a below average score, so its downtrend has led them to earning last place each of the past two years. Johnson & Johnson was handily in 1st place in 2017, but now in 2019, it's barely holding on to 2nd. Finally, the most revealing trend of the group was Pfizer. They managed to improve their debt score from an abysmal 4.33 in 2017 all the way to 2.5 in 2019- a remarkable improvement. Although it is still just in 3rd place, the jump they made is impossible to ignore.

Profitability

JNJ

ABBV

MRK

GILD

PFE

Gross Margin

66.92% (5)

76.93% (3)

68.11% (4)

78.07% (2)

79.26% (1)

Operating Margin

22.06% (3)

19.49% (5)

19.62% (4)

37.58% (1)

22.78% (2)

Net Margin

18.75% (3)

17.63% (4)

14.64% (5)

24.69% (1)

19.35% (2)

Profit Per Employee

$113,227 (4)

$189,567 (2)

$89,753 (5)

$496,364 (1)

$121,082 (3)

Return on Assets

9.86% (1)

8.87% (2)

7.26% (4)

8.16% (3)

6.27% (5)

Effective Tax Rate

15.01% (3)

-11.08% (1)

28.82% (4)

29.94% (5)

12.64% (2)

Current Profitability Scores

1. Gilead- (2 + 1 + 1 + 1 + 3 + 5) / 6 = 2.17

2. Pfizer- (1 + 2 + 2 + 3 + 5 + 2) / 6 = 2.5

3. Abbvie- (3 + 5 + 4 + 2 + 2 + 1) / 6 = 3

4. Johnson & Johnson- (5 + 3 + 3 + 4 + 1 + 3) / 6 = 3.17

5. Merck- (4 + 4 + 5 + 5 + 4 + 4) / 6 = 4.33

Gilead holds another 1st place spot, this time for profitability. Pfizer had another above-average score of 2.5, which was enough to move it into 2nd place. With a perfectly average score of 3, Abbvie took 3rd place, only slightly edging out Johnson & Johnson, who scored a 3.17. In last place was Merck, whose profitability ratios were last or second to last compared to the rest of the pharma companies in this analysis. Below is a table and graph illustrating the profitability scores over the past three years:

'17 Profitability Score '18 Profitability Score '19 Profitability Score

Johnson & Johnson

3.17 3.67 3.17
Abbvie 2.83 2.17 3
Merck 4.83 4 4.33
Gilead 1.5 1.67 2.17
Pfizer 2.67 3.5 2.5

The multi-year trends of profitability scores are much more volatile than the debt scores. That being said, there is still some valuable insights to be gained. Merck improved the most over the last 3 years, but it was not enough to pull them out of last place. Pfizer, although incremental, also improved its score, from 2.67 in 2017 to 2.5 in 2019. Towards the top of the list, there is less room to improve, so any improved score by a company who already has a good score shouldn't be taken lightly. Johnson & Johnson ended up exactly where they were in 2017, returning back to normal after their score suffered in 2018. Both Abbvie and Gilead saw their scores heighten, meaning their position among the others worsened, although in different magnitudes. Abbvie only dropped a little going from 2.83 to 3. As more data gets added, it will be intriguing to see if a sustained downtrend continues and pushed the profitability score into below-average territory. The strongest move of the group was Gilead, but it was not in the correct direction. Their score worsened each year, but as mentioned earlier, it would have been difficult to maintain their 2017 score of 1.5 for a long period of time because it's simply because there is more room to fall.

Efficiency

JNJ

ABBV

MRK

GILD

PFE

Revenue per Employee

$603,856 (4)

$1,091,766 (2)

$612,956 (3)

$2,011,545 (1)

$580,595 (5)

Employee Cost Per Unit of Revenue

.276 (5)

.226 (2)

.238 (3)

.183 (1)

.269 (4)

Capital Expenditure Ratio

22.23 (4)

51.34 (1)

16.17 (5)

23.95 (3)

24.43 (2)

Return on Equity

25.51% (2)

-439% (5)

20.38% (3)

26.10% (1)

15.37% (4)

Return on Invested Capital

12.31% (1)

11.99% (2)

9.58% (4)

9.80% (3)

7.74% (5)

Asset Turnover

.53 (1)

.50 (2)

.50 (2)

.33 (4)

.32 (5)

Current Efficiency Scores

1. Gilead- (1 + 1 + 3 + 1 + 3 + 4) / 6 = 2.17

2. Abbvie- (2 + 2 + 1 + 5 + 2 + 2) / 6 = 2.33

3. Johnson & Johnson- (4 + 5 + 4 + 2 + 1 + 1) / 6 = 2.83

4. Merck- (3 + 3 + 5 + 3 + 4 + 2) / 6 = 3.33

5. Pfizer- (5 + 4 + 2 + 4 + 5 + 5) / 6 = 4.17

So far, in all three categories presented, Gilead has taken 1st place- this time in efficiency. They ended marginally higher than Abbvie, who scored a 2.33 and earning 2nd place. The last of the above-average performers is Johnson & Johnson, who inched just beyond the 3 mark to earn a 2.83. On the other side of things, Merck scored a 3.33, and if we move nearly another point down the ladder, we see Pfizer scored a 4.17 and a last place finish. Here are the historical trends of each company's efficiency score:

'17 Efficiency Score '18 Efficiency Score '19 Efficiency Score
Johnson & Johnson 3.33 3.17 2.83
Abbvie 2 1.67 2.33
Merck 3.83 3.83 3.33
Gilead 1.33 2 2.17
Pfizer 4.5 4 4.17

One noticeable trend is that three stocks improved upon their original score given in 2017. Even though Merck and Pfizer stayed in 4th and 5th place in each year, they were able to gain some ground on Gilead and Abbvie in the profitability category. Johnson & Johnson also saw promising growth, moving from below average to above average from 2017 to 2019. Interestingly, the two top performers in the last 3 years each saw deterioration in their scores. Gilead went from 1.33 to 2.17, and despite remaining in 1st place, a drop in score of nearly a full point is not an encouraging sign. Abbvie's drop wasn't quite as significant, but in the end, the standard deviation in scores of the five stocks is much lower as they are starting to converge.

Growth

JNJ

ABBV

MRK

GILD

PFE

EPS Growth

8.14% (3)

10.02% (2)

-24.89% (4)

-59.89% (5)

17.37% (1)

Revenue Growth

13.48% (2)

27.75% (1)

6.25% (3)

-27.19% (5)

1.56% (4)

Debt Growth

12.36% (5)

9.41% (4)

1.09% (2)

3.7% (3)

-.82% (1)

Free Cash Flow Growth

19.24% (2)

94.89% (1)

-5.19% (4)

-54.13% (5)

-4% (3)

Working Capital Growth

101% (1)

33% (3)

40.29% (2)

-160% (4)

-220% (5)

Current Growth Scores

1. Abbvie- (2 + 1 + 4 + 1 + 3) / 5 = 2.2

2. Johnson & Johnson- (3 + 2 + 5 + 2 + 1) / 5 = 2.6

3. Pfizer- (1 + 4 + 1 + 3 + 5) / 5 = 2.8

4. Merck- (4 + 3 + 2 + 4 + 2) / 5 = 3

5. Gilead- (5 + 5 + 3 + 5 + 4) / 5 = 4.4

With a score of 2.2, Abbvie beat out Johnson & Johnson and Pfizer to earn the top spot, who scored 2.6 and 2.8, respectively. Right in the middle is Merck with a 3, but it only earned them a 4th place spot. Uncharacteristically, Gilead finished way behind the rest of the group in this category. They earned a 1st place spot in each of the first three categories, so scoring a 4.4 in growth will definitely hurt their overall score. Here are the growth scores for each company for the last 3 years:

'17 Growth Score '18 Growth Score '19 Growth Score
Johnson & Johnson 3.2 2.6 2.6
Abbvie 3 2 2.2
Merck 2.8 3.6 3
Gilead 3 4.2 4.4
Pfizer 3 2.6 2.8

Gilead had the most notable move of the group- going from a respectable 3 in 2017 down to a 4.4 in 2018. Because of this, the stock went from finishing in the middle of the group to being in last by a wide margin. The other stock to lose ground was Merck, who after dropping to 3.6 in 2018, re-established an average score of 3 for the current year. The stocks that improved by no means saw extravagant jumps in their scores, but are impressive nonetheless. Pfizer's move from 3 to 2.8 was not enough to maintain the 2nd place it shared with two others in 2017, with Abbvie breaking the tie and enhancing its score down to the present day sum of 2.2. The other big gainer was Johnson & Johnson, who propelled themselves from last place in 2017 all the way to 2nd place in 2019, passing three other stocks over the period of time.

Final Scores

Weighting Categories

After implementing performance based weighting to each category, I have determined that the Profitability ratios are most correlated to price performance, followed by Debt, Efficiency, and then Growth. Therefore, instead of the equation for finding the cumulative score of a stock looking like this:

(Debt Score x .25) + (Profitability Score x .25) + (Efficiency Score x .25) + (Growth Score x .25) = Final Score

It now looks like this:

(Debt Score x .27) + (Profitability Score x .3) + (Efficiency Score x .25) + (Growth Score x .18) = Final Score

With this weighting, more value is given to categories with the greatest correlation to price performance, which in turn should lead to more accurate final scores. To answer any lingering questions about how I determine weighting, please see my article that introduces the concept. Here are the most recent weight-adjusted scores for the pharmaceutical industry:

1. Gilead- 2.53

2. Johnson & Johnson- 2.76

3. Pfizer- 2.97

4. Abbvie- 3.05

5. Merck- 3.71

Adjusting For Share Buybacks

In my most recent article, I introduced how share repurchases can influence share price, and thus, why my future analyses will attempt to account for companies' strategies in this area. For more details on how I determine these upcoming weights, please see the article that explains its implementation. In short, I standardize each companies rate of common shares outstanding reduction to have an effect of between -.1 and .1, with the stock that retires the greatest percentage of its shares to receive the .1 improvement in its score and so on. Here is a table showing the data:

'17 Total Shares Outstanding (million) '18 Total Shares Outstanding (million)
Johnson & Johnson 2,683 2,662
Abbvie 1,592 1,479
Merck 2,697 2,593
Gilead 1,308 1,282
Pfizer 5,979 5,717

List of Top Share Repurchasers

1. Abbvie: -7.10%

2. Pfizer: -4.38%

3. Merck: -3.86%

4. Gilead: -1.99%

5. Johnson & Johnson: -.78%

Now we can find the weights to add on to each final score:

% of Common Shares Retired Standardized Effect on Scores Original Score Adjusted Score
Johnson & Johnson -.78% +.1 2.76 2.86
Abbvie -7.10% -.1 3.05 2.95
Merck -3.86% -.008 3.71 3.70
Gilead -1.99% +.044 2.53 2.57
Pfizer -4.38% -.023 2.97 2.95

After accounting for both weights final positions look like this:

1. Gilead- 2.57

2. Johnson & Johnson- 2.86

3. Abbvie- 2.95

3. Pfizer- 2.95

5. Merck- 3.70

After a solid performance in the debt, profitability, and efficiency categories, Gilead ended up with the best score of the group. Johnson & Johnson took 2nd place, succeeding in scoring below the 3 mark despite weaker buybacks than other stocks included in this analysis. Tied for 3rd were Abbvie and Pfizer, who each sport a score of 2.95, and in last place, Merck. Merck was the only company that didn't finish under 3, which can largely be attributed to its poor displays in the debt and profitability ratios. Included below is a table and graph showing historical final scores over the past three years:

'17 Final Score '18 Final Score '19 Final Score
Johnson & Johnson 2.82 2.95 2.86
Abbvie 2.98 2.56 2.95
Merck 3.69 3.95 3.70
Gilead 1.76 2.35 2.57
Pfizer 3.94 3.11 2.95

An overarching trend I see immediately upon looking at the graph is the convergence of scores over the last three years. For example, in my first year of data, Gilead scored an incredible 1.76- easily securing 1st place. Then over the next two years, its score dropped pretty significantly, all the way to 2.57 today. It is still worth noting that Gilead remained in the top spot each year, but their score continually worsening does not seem very favorable.

Albeit scores for each category had some volatility, the opposite occurred in the culmination of these final scores. Three stocks didn't see much net change in their final scores: Merck, Abbvie, and Johnson & Johnson. It may be a good thing to be consistent if a stock's score is already good, but Merck's was poor. That means the consistent nature of their score was largely due to inability to catch up to their peers in most categories of this analysis. Abbvie and Johnson & Johnson, on the other hand, began with pretty solid scores, so their consistency is more tolerable.

The most assuring movement came from Pfizer. They began the analysis in dead last, but as time went on, were able to improve their place among competitors by an entire point- going from 3.94 to 2.95. This was enough to put them in a tie for 3rd place with Abbvie. This type of movement is one of the things I value with this research because it means Pfizer is gaining ground on the rest of the members of the group. And if my theory holds any weight, passing competitors like this and maintaining this advantage would bode well for the returns of its stock price.

Conclusion

There is also year over year trends to analyze, and although they can be interesting, they are not the primary goal of my research. However, now that I'm starting to get more and more data, a lot of statistics can be created relating scores of stocks to price performance. Instead of adding them to this already lengthy article, I will create new articles where I update everyone on statistics that I discover through scrutinizing the data- and I'll try to make it as unbiased as possible by including statistics that support my thesis as well as go against it.

The research I'm conducting isn't meant to perfectly encapsulate a stock's well-being or future earnings potential, as ratios can only tell so much about a business. However, I feel that it does provide a helpful supplement to someone who is trying to complete a full fundamental analysis of a company or industry. As always, any suggestions are welcome and feel free to leave any feedback in the comment section.

Disclosure: I am/we are long JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.