There is a time to buy the large-cap drug stocks. If you buy these pharmaceutical giants at the right time, you can own them for years and can collect huge dividends while enjoying steady appreciation in the price of your shares.
This is not that time.
The right time to buy large drug stocks looks a lot like late 2008 and early 2009. The stocks were all trading near and even below 10 times earnings as prices bottomed. The shares yielded over 5% and were a perfect selection for growth as well as income-oriented investors.
If you purchased back then, you have made an enormous amount of money from some of the financially safest companies in the world. Buying them today after seven years of almost straight-line appreciation makes very little sense though, and is likely to lead to losses for in excess of the dividend payments.
Here are three I suggest you leave alone right now.
Blue Chips to Avoid: Johnson and Johnson (JNJ)
Johnson and Johnson (JNJ) is a great example of drug stocks gone wild.
To be clear, this is one of the greatest companies in the world, and I am pretty sure that you have their products throughout your home. In addition to their fantastic collection of consumer brands, they are active in drug development and biotechnology. They have an extensive medical device operation, developing devices for the orthopedic and cardiovascular markets.
You could have bought the stock right around 10 times earnings with a 5% yield back in 2009 and would have enjoyed solid, low-risk returns since then.
Today the stock trades at 21 times earnings and yields less than 3%. Earnings growth for the next several years will be about 6%, unless the global economy slows further and lowers that estimate.
It is one of the greatest companies in the world, but the stock is a terrible buy at this level.
Blue Chips to Avoid: Bristol-Meyers Squibb Co (BMY)
Bristol-Meyers Squibb Co (BMY) is an even better example. At the market lows, you were paying seven times earnings and the dividend yield was around 7% for this world-class blue-chip drug stock.
The returns since the lows of 2009 are in excess of 20% annually. The stock was a wonderful buy.
Again this is a great company that has important drugs for some of the biggest health problems in the world, including cancer, HIV, cardiovascular disease and other life-threatening conditions — and they have more drugs in development that can solve more of the world’s health problems.
However the stock trades at 22 times the always highly accurate analyst efforts for the next year and is yielding just 2.1% at the current price.
It is worth noting that we have seen some sizeable insider sales in the past few weeks. It is a wonderful company trading at a horrible price.
Blue Chips to Avoid: Eli Lilly and Co (LLY)
At the risk of singing the same song over and over the picture is similar at Eli Lilly and Co (LLY).
They have products that treat widespread conditions like depression, attention deficit disorder, fibromyalgia and anxiety and panic disorders. They have cancer drugs for on-small cell lung, colorectal, head and neck, pancreatic, metastatic breast, ovarian, bladder and metastatic gastric cancers as well as cardiovascular drugs.
To top it all off, they are a major producer of animal health drugs for both farm animals and household pets.
In 2009 you would have been buying the stock at less than 10 times earnings with a yield of more than 7%. Today the shares fetch 33 times trailing and 19 times expected earnings and yield just 2.7%.
It is a great company, but the shares are too rich to buy here.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities. He is the author of the Banking on Profits newsletter covering the community bank stock opportunity and the Deep Value Report that seeks out undervalued stocks that are likely to survive until they thrive and capture the value effect that has been proven to beat the market over time.
