Black Friday Bargain Stock: Dr. Reddy's Laboratories

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I'm going to win this "best bargain stock" contest with just two numbers: 152% and 10. The former is year-over-year income growth at Dr. Reddy's Laboratories (NYSE: RDY). The latter is its trailing-12-month P/E ratio.

I can't think of another industry in which a company that's more than doubling its income every year deserves to be valued at just 10 times earnings. If Dr. Reddy's keeps up that kind of growth, and the stock price doesn't change, in three years it'd be earning more than its entire valuation.

Consistently inconsistent
There's always a catch, right? There are probably several reasons why Dr. Reddy's doesn't get much love from investors. The most obvious may be how few people know about it. The company has been ranked just 205 times by Fools in our CAPS community, compared to almost 7,600 rankings of Google, or the more than 2,600 rankings of Pfizer (NYSE: PFE). Remember, Fools, unrecognized stocks can sometimes add stellar growth to your portfolio.

Another problem for Dr. Reddy's is that its growth is slowing. Investors have gotten used to astounding growth here, but its deceleration this year to one-third its previous speed could explain Dr. Reddy's 15% drop in stock price since the beginning of the year.

Metric	Jun-06	Sep-06	Dec-06	Mar-07	Jun-07	Sep-07
Net Income (in millions)	$54.9	$96.3	$128.6	$216.1	$248.5	$242.8
Year-over-year increase	517%	460%	330%	490%	353%	152%

All data courtesy of Capital IQ, a division of Standard & Poor's.
Data reflects trailing-12-month performance for the quarters ended in the named months.

I'd also point out that I cheated just a little in the above chart. Like fellow generic-drug makers Teva Pharmaceuticals (Nasdaq: TEVA) and Barr Pharmaceuticals, Dr. Reddy's has some serious rollercoaster earnings. Authorized generics or first-to-file status shoot earnings into the sky, but those figures plummet back to earth as the drugs' exclusive periods end. I've smoothed out the numbers in the above chart by including the trailing four quarters.

Quarter-over-quarter comparisons -- including a 37% drop in revenues last quarter -- could earn Dr. Reddy's a spot on our scariest stocks list. And that might be the ultimate reason why Dr. Reddy's is such a bargain; investors just can't take the roller-coaster earnings.

Growth potential
Dr. Reddy's has almost 70 Abbreviated New Drug Applications (ANDAs) pending with the FDA, which puts it on track to launch six to eight new products every year for the next few years. But the true growth potential for Dr. Reddy's lies in its push towards bringing follow-on biologics to market -- generic versions of biotech drugs like Amgen's (Nasdaq: AMGN) anemia drug EPOGEN or Genetech's (NYSE: DNA) cancer drugs.

I have no idea whether it'll be 2008, 2009, or even later before Congress gets around to allowing the FDA to approve follow-on biologics, but a law will be passed eventually. Dr. Reddy's is making a shrewd move to expand its capabilities to sell more follow-on biologics in India. Since biotech drugs are harder to copy than small molecules, starting early should help it compete well against the European market leader, Novartis, once a pathway for approval is established in the U.S.

Final Foolish thoughts
Dr. Reddy's probably won't ever be a dream stock. It just doesn't have the household name of Johnson & Johnson (NYSE: JNJ) or Merck (NYSE: MRK). But it will break out of its funk once investors realize that 150% growth doesn't deserve a P/E of 10. You might want to buy before it's too late.

Do you agree that Dr. Reddy's got something cooking in the laboratory? Cast your vote by pegging the Doctor as an outperform in Motley Fool CAPS. Then come back next week, when we let you know which company the collective picked as the best bargain this holiday season.

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