Eighteen months after Zoetis (ZTS -4.32%) was spun off from its parent, Pfizer (NYSE: PFE), in 2013, the animal-health company's stock had risen a meager 5%. It's a different story today, though. Zoetis stock continues to set new highs and is trouncing the S&P 500 index in 2017.
But can the sizzling momentum for Zoetis continue? Here are three things that could cool the stock down.
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1. A market correction
Probably the most likely thing that could derail Zoetis from going higher is a major market correction. By definition, a market correction is a drop of at least 10%. The stock market undergoes a correction, on average, about once every year. For what it's worth, the last correction for the S&P 500 was a brief one in late 2015 and early 2016. We're overdue for another.
It has also been quite a while since the U.S. economy went through a recession and caused a bear market (typically defined as a 20% drop from peak levels). Since animal lovers will still care for their pets and farmers will still need supplies for livestock, Zoetis could be seen as somewhat recession-proof. However, tough economic times could still take a toll on the stock if fewer families get pets and demand for meat falls.
Interestingly, Zoetis' beta of 1.24 indicates that the stock is more volatile than the overall market. Also, during those overall market corrections of the past couple of years, Zoetis stock fell at least twice as much as the S&P 500 did. If there's a market correction, Zoetis is likely to feel the pain.
2. Its premium valuation
Even if the market doesn't correct, Zoetis stock could have its own correction if investors become leery of its valuation. The animal-health company's shares currently trade at 36 times trailing-12-month earnings and over 23 times expected earnings. Zoetis stock isn't cheap.
But what about growth? Don't expectations for high growth help justify a high valuation for a stock? Usually, that's the case. However, Wall Street analysts project that Zoetis will grow its earnings by an average annual rate of around 13% over the next few years. That's not bad, but it's well below earnings growth levels from the past five years. And it's not high enough to make the stock's valuation seem much more attractive.
3. Increased competition
Although Zoetis has been tremendously successful, the competition in the animal-health market is intense. It's probably going to increase even more.
Merck (MRK 0.44%) is making a play to give Zoetis a run for its money in the Latin American market. Merck Animal Health completed an acquisition of Vallee S.A. in March. Vallee is a leading producer of animal-health products in Brazil.
Zoetis already lags behind at least one major rival in all geographic areas outside of North America and South America. With the middle class growing especially fast in Asian countries, the company certainly doesn't want to give up market share.
Sizzle to fizzle?
Will Zoetis stock really go from sizzle to fizzle? Probably not.
The risks mentioned above are real. However, even if the stock suffers from a market correction, it would likely only be a short-lived setback. Investors could steer clear of Zoetis over valuation concerns, but the stock's earnings multiple isn't out of line with historical levels for the company. And if Zoetis takes some licks from Merck or another major rival in one region, you can bet the company will fight back aggressively.
Over the long run, there are several factors that should help Zoetis stock go even higher. The company's share price will inevitably retreat somewhat sooner or later, but I think Zoetis remains a solid pick for investors.
