During the past 10 years or so, investors have come to appreciate — and implement — the sector diversification pie chart. It’s a neat and tidy tool to make sure your stock portfolio is balanced, and there’s just something subconsciously rewarding about well-proportioned geometrical shapes.
But sometimes, the creation of a well-proportioned pie chart can detract from the more important goal of owning the very best stocks you can.
Said another way: If your pharma sliver of pie is too small, it’s easy to fall into the “any old pharma stock will do” trap and just shove a second-rate name into the mix. Big mistake. The goal should be to find the best of the best names for every sector represented in your holdings. See, at the end of the day there are only one or two great companies in a particular industry, and the rest are simply along for the ride.
With that in mind, here’s a rundown of the U.S. pharmaceutical industry’s major stocks, from weakest to strongest. As you’ll see, only two of them are actual “must-own” names.
To be clear, just because Pfizer (NYSE:PFE), Johnson & Johnson (NYSE:JNJ) and Abbott Laboratories (NYSE:ABT) are at the bottom rungs of the pharmaceutical ladder doesn’t mean they’re horrible companies. All three are among the industry’s biggest companies for a reason. However, all three are facing — or soon will — bigger challenges than they might be able to fully abate.
For Pfizer, that hurdle is the loss of patent protection on Lipitor. The cholesterol-fighting drug generated about $11 billion in sales for the company last year, or about 16% of the company’s sales (and roughly 19% of profits). Though it’s only been a few months since the U.S. patent expired, generic versions already have taken a big bite out of Pfizer’s business. The outfit is working hard to develop other drugs to make up for those lost sales, but it’s just not easy to replace the world’s most successful drug ever.
As for J&J and Abbott, neither of them are lighting it up on the earnings front either.
Yes, Johnson & Johnson recently was upgraded, but the company’s profit stagnation (and more recent decline) isn’t something that magically disappears over time. While it’s working to fight its way out of a slump, it’s going to take much more than the Synthes deal and a new CEO (who’s already been tainted) to do so.
In the interest of fairness, yes, I was a huge fan of Abbott’s brewing technical breakout back in October. The problem is, the stock rallied much farther than earnings have improved. Now it just looks frothy for no good reason.
OK, GlaxoSmithKline (NYSE:GSK) actually is a United Kingdom company. But it has such an enormous presence in the U.S. market that we can reasonably throw it into the pool — even if only to call it a mediocre pick. Though the stock has been broadly on the rise since early 2009, neither the top line nor the bottom line has budged.
And, for whatever reason, Glaxo might be steering away from the gene therapy game by declining to even participate in the invitation-driven bidding process for Human Genome Sciences (NASDAQ:HGSI). Human Genome was willing to discuss its ongoing strategic alternatives with Glaxo — which might include an outright sale — but it looks like the U.K.-based drugmaker wants to do it its way (by appealing directly to shareholders), or no way at all.
Merck & Co. (NYSE:MRK) hasn’t been able to meaningfully grow earnings in more than a decade. There’s not much in the pipeline that’s going to change that, either.
So what does that leave us as the top names in the U.S. pharmaceutical world? Bristol-Myers Squibb (NYSE:BMY) and Eli Lilly & Co. (NYSE:LLY).
Bristol-Myers Squibb is one of the few major pharma names that’s actually growing the bottom line, and seeing its shares move higher accordingly. That hasn’t always been the case, though.
BMY ran into some real sales trouble in 2002, sending the stock from $55 to $20, where it essentially stayed until last year. Earnings have been steadily on the rise again for a while, though, ramping up from trailing 12-month profits of $1.07 per share in 2007 to the latest figure of $2.22 per share — the best results we’ve seen since the lull began in 2002. Yet, the stock is only now starting to make higher highs, and there’s a ton of room to recover before retesting 2001’s peak prices. And at a P/E of only 15.5, there’s no big valuation hurdle to get over.
As for Eli Lilly — the smallest of the seven in question — it’s also on the mend, but from the nastiest, most undeserved selloff for any major pharmaceutical manufacturer in the past decade. Shares were in the mid-$70s in the year 2000, but reached a low of $32 in early 2009.
Earnings getting killed? Not really. The market mostly overreacted to worries of problems that never materialized.
Shares have been in rebound mode since 2009, but at about $42 there’s still a lot of room to run, particularly with a trailing P/E of only 10.8. Not to mention LLY yields roughly 4.6% in dividends. And Lilly features a broad pipeline (including blood pressure, diabetes and weight-loss drugs), as well as a willingness to deal with a lot of R&D and marketing partners (Boehringer Ingelheim, Incyte and Novast just to name a few).
There’s no one single thing that makes the company great. It’s just that the market hasn’t fully appreciated that Lilly does a lot of different things very, very well — much better than most of its competition.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.