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No. of Recommendations: 13
I've been reading Dremen's "Contrarian Investment Strategies" lately,
and came across this little historical item.

In the depths of the great pharma sell-off crisis of the early 1990's, the
pharmaceutical sector dropped from its relatively normal high P/E ratio of 26
to the insanely low value of 16.5, one of the great buying opportunities of recent decades.
I hear it was something about somebody named Hillary, but the reasons don't matter.
The two points are (1) this is a sector with a historically high valuation
multiple because of its tendency to large, steady, and rapidly increasing earnings, and
(2) if you buy them when they're unusually cheap, you generally do well.
These stocks roughly tripled in price from early 1994 to early 1997.

Currently, the 7 largest drug companies in the Value Line database are:
Pfizer, Glaxo, Novartis, Sanofi-Aventis, Merck, Wyeth, and Lilly.
These are now trading at an average P/E of 14.92 using VL's method of
averaging trailing and forward earnings; using trailing 4 quarters
of as-reported earnings, the average is 15.78.

Are they great companies?
The top 7 firms have an average EBIT/tangible assets earnings rate of 46.6%.
That's an amazing number.

Is this a good entry point?
These firms are on average 13.7% off their 52-week highs.
Not a panic sell-off, but a nice point anyway.

Are they overleveraged or otherwise risky?
Any one of them could pay off all their debt with under a year's earnings.
(well, Sanofi might take 15 months...)


Is it just these few companies?

If we add the next 5, Bristol-Myers, Schering-Plough, Gilead, Novo Nordisk, and Teva,
the VL method average is 18.0, and trailing-4-quarters method is 19.85.

A market-cap-weighted average of all the drug stocks covered by VL,
excluding those without meaningful P/E ratios, gives an industry
average of 17.00 (again, VL's trailing-and-forward method) for 36 companies.


Bottom line:
It seems to me that the pessimism surrounding the drug industry is again overdone.
Investors are always fretting about drug pipelines running dry,
yet patients--the same crowd--keep buying more drugs. And obviously
they usually buy most of those drugs from the biggest companies.
Meanwhile, these are the poster kids for flight-to-safety in case
the markets do something nasty, or when the next bear market starts.
With valuation, secular, and cyclical stars aligned, looks like a good long-term buy to me.
An equally-weighted portfolio of the top 7-10 by market cap should do well.
My particular favourite is Pfizer, though it requires a detailed valuation
analysis to break it into "The Lipitor Declining Income Trust" and
"The Hidden Growing General Drug Company".
I also like Johnson&Johnson, though Value Line categorizes it as
"medical supplies", at an EBIT/tangible capital of 85% and a P/E of 15.1

Jim
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