3 Foolish Reasons to Buy This Expensive Stock

Make no bones about it -- Zoetis (NYSE: ZTS  ) is one expensive stock. It even might be the most expensive health-care stock for its size. If you don't believe me, run a stock screener for other companies of its size (at least $4 billion in annual revenue and $1 billion in EBITDA) with a trailing price-to-earnings multiple above 35. You'll find fewer than 40 other stocks fitting the bill, none of them even remotely connected to health care. 

Would buying Zoetis at the current price be foolish? Or could buying shares actually be Foolish (i.e., The Motley Fool kind of smart)? Here are three reasons -- both foolish and Foolish -- to buy this expensive stock.

1. Pets are multiplying like rabbits
You'd be foolish to buy Zoetis just because increasingly more people own pets and the company makes animal health products for those pets. For one thing, we need to question how much pet ownership really is on the upswing. The American Pet Products Association reported in 2008 that 62% of all U.S. households owned a pet, up from 56% in 1988. What is the figure for 2012? Still 62%. Of course, the number of households is growing, so pet ownership is actually increasing, albeit at a relatively slow rate.  

The Foolish approach is to follow the money trail. While pet ownership might be growing at a snail's pace, spending on pets is hopping along more quickly.

Source: American Pet Products Association.

This represents a large market, of which Zoetis currently only captures less than 8% -- and we're not including the rest of the world. A Foolish reason to consider buying the stock is that the company's status as the largest animal health business could position it to capture increasingly more of this growing market.

2. Steak and hamburgers really taste good
Another foolish reason to scoop up Zoetis shares right now is that you think demand for its products will soar because more people across the world will become as carnivorous as Americans. Everyone knows that rising middle classes in developing countries will want to eat more meat, right? More meat equals more need for Zoetis' veterinary products to keep livestock healthy.

However, keep in mind that not even Americans are as carnivorous as Americans used to be. The U.S. Department of Agriculture reports that our annual consumption of beef and veal has been decreasing each year since 2007, except for a small uptick in 2012.

What about the rest of the world? The same trend holds true for China. Beef consumption in Europe, Mexico, and Russia has steadily declined with no upticks. There are areas of growth, though. India and Japan, for example, have experienced increases in beef consumption over the last five years. When we look at the total of all countries, however, the surprising fact is that beef consumption has been dropping.

Foolish investors, though, look at the long term and understand that shorter trends can change. For example, worldwide beef consumption in 2013 is projected to be higher than 2012. They also look at the big picture. Zoetis doesn't only provide health products for cattle. The company also markets products for pigs and poultry. Global consumption continues to rise for both. 

3. Everybody else is buying it
One of the the most foolish mistakes in investing is buying a stock simply because others are buying it. Do any words of wisdom from your mother about jumping off a cliff come to mind? 

Foolish investors ask why so many people are buying Zoetis. Some of the frenzy could simply be the thrill of the biggest IPO since Facebook (NASDAQ: FB  ) . That comparison should provide a sobering lesson, though. Shares of the social networking giant still haven't regained the levels experienced at the IPO. The market appears to be liking Zoetis a lot more than Facebook so far.

The reasons why this is true probably tie in at least partially with the fundamentals we already covered about increased pet spending and prospects for higher levels of meat consumption across the world. Zoetis actually doesn't boast the strongest growth in this market, though -- at least not recently.

Prior to the spinoff, Pfizer (NYSE: PFE  ) reported that its animal health business (that would become Zoetis) grew sales by only 2% for the first nine months of 2012 compared to the same period in 2011. By comparison, Lilly (NYSE: LLY  ) increased its animal health revenue by 22% during the first nine months of 2012, with a boost from an acquisition in the second half of 2011. Merck (NYSE: MRK  ) grew animal health sales by 5% during this same period. However, both Lilly and Merck have kept their animal health units in-house. Zoetis is attractive to investors because the stock represents the only pure play publicly traded animal health business. 

Foolish take
So should you buy Zoetis? Yes -- if you believe the business fundamentals in its favor (and there are several) justify the steep price. Otherwise, the answer is no.

My take is that Zoetis is a great business with solid prospects. However, its growth prospects, while quite good, aren't great enough to justify a P/E of 37 in my opinion. I'm just too much of a Fool to think differently.

Should Lilly follow Pfizer's footsteps after the successful spinoff of Zoetis? Over the next two years, Eli Lilly will see nearly $0.40 of every $1.00 in sales exposed to generic competition. How does the company plan to respond to this huge patent cliff? Better yet, what does this mean for investors? In a brand new premium report on Eli Lilly, The Motley Fool's top pharmaceuticals analyst delves into everything investors need to know about the stock today. Simply click here now to claim your copy.

 


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