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by Cynthia Robbins-Roth, Ph.D.
Much Like Peter Pan, Big Pharma Won't Grow Up
By Cynthia Robbins-Roth
BioWorld Today Columnist
Why are big pharma companies driven to pretend they are still young, innovative growth companies, able to generate that infamous double-digit net earnings growth year over year?
Ever since the big firms started the mega-merger fad, CEOs have focused on how their latest strategic move will get the company back to - yes, you guessed it - double-digit net earnings growth! In many cases, the business wisdom of those moves has been tough to discern. Once you hit $1 billion-plus in net profit, growing at 20 percent gets tricky.
Biotech companies, who look to big pharma as role models, are addicted to the double-digit net earnings growth, too. Of course, most of them actually can deliver that growth when starting from $0 net profit.
Is it inevitable that our most successful companies will become the corporate equivalents to Hollywood starlets, refusing to stop bleaching and dressing like teenyboppers?
Is there life after becoming a value stock?
Allocation Is The Key
Craig Pieringer, a portfolio manager at Wells Capital Management, said one of the basic rules of investing is asset allocation - placing your bets in different asset classes that tend to vacillate independently in the markets. Typically, the first cut is large vs. small cap and the second is value vs. growth.
Ibbotson and Sinquefield, professors who originally looked at returns dating back to the 1960's, found that small cap value stocks were one of the best performing asset classes, Pieringer said.
So why the resistance to the natural evolution from being a growth stock to being a value stock, when smart investors want both?
Maybe because it often is a painful experience. Growth stocks have high stock prices, high multiples, high year-over-year growth in net earnings. To become a value stock from that point, Pieringer said, companies "have to disappoint, which is detrimental to the existing shareholders."
It doesn't have to end there, though. After that transition, the new investors are value investors and can share in future price appreciation, he said.
Growth Vs. Value
Joe Aguilera, biotech hedge fund manager at BioRevolution Capital Management LLC, said that growth stock revenues can escalate 30 percent to 50 percent annually - faster than the overall industry or market, with net earnings growing at a similar pace.
People will pay ridiculous [price/earnings] multiples for these, because they are so convinced these stocks will keep growing, he said. These stocks pay little or no dividends, and use the income to finance expansion.
But there is risk along with the wonderful upside potential. Disappoint your investors, even by pennies per share in the quarterly net earnings, and your stock price can plunge precipitously.
Genentech reported fourth-quarter/2005 net income that jumped 64 percent to $339 million (31 cents per share) vs. $206.6 million (19 cents per share) over the same period in 2004. Investors were disappointed enough, though, to send share price down 2.5 percent in after-hours trading.
Kudos to Amgen Inc. for telling investors to expect slower earnings growth in 2006. Company officials said it would sink 30 percent to 40 percent more into R&D. That doesn't give double-digit growth tomorrow, but it does solidify a future.
News that even suggests a speed bump on the road of growth makes stocks drop like rocks. Google, the growth king, went from $475 per share on Jan. 12 to $402.63 on Jan. 20 on news of its face-off with the federal government over privacy.
Most companies evolve into a value stock over time, as they penetrate their product markets and put less investment in new markets and R&D. They become cash cows, milking that hard-earned investment made in their growth phase. Net growth is less than 10 percent, with enough cash flow to pay dividends. The total yield of dividend plus stock appreciation can keep investors pretty happy when more volatile stock classes crash.
There are value investors who see opportunity in the disappointment of others. Stocks tend to be oversold with bad news, Pieringer said, creating a buy opportunity. Sometimes share price is low because the companies don't need to raise capital, and so don't get the support of Wall Street.
Those stocks can offer patient investors a good return over time as they start posting growing earnings, and getting newsflow with management or product opportunities. Value investors are looking for an earnings turnaround in the next 12 to 24 months.
Aguilera agreed that when value stocks are out of favor, that's the time to buy. Humana went from $4.75 to $58.26. Corning was at a low of $1.50 per share in August 2002 and losing money. It got into new technology, cut budgets and saw lots of insider buying on the lows. Today, it is earning money and $25.76 per share, he said.
Growth Vs. Value In Biotech
Most biotech stocks are firmly in the growth category these days. For those companies lacking marketed products, it is the expectation of huge revenue that drives investors.
Big pharma companies are fighting hard against the value name tag.
Aguilera sees Pfizer Inc. as a great example of a value stock. The company announced 2005 revenues of $51.2 billion, net profit at $8 billion and a dividend of $1.10 per share. Numbers for 2004 were $52.5 billion total revenue, $11.3 billion net profit and dividend of $1.52 per share. Share price dropped from $38.89 in February 2004 to $29.21 in June to $23.32 in December.
So why buy Pfizer? Aguilera said that it's a relatively safe play.
If net profit goes up even 2 percent, the stock should move, he said. To get a 10 percent growth in the total package of income from the 3.85 percent [Pfizer just increased first quarter dividend by 26 percent] dividend yield and stock price appreciation, the stock only needs to go up $1.53 per share to give that 10 percent growth total! That's not bad - lots of folks would be happy with that.
-- January 30, 2006
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by Cynthia Robbins-Roth, Ph.D.
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