Why Tapering Is Great News for Allergan Inc.

How growth stocks like Allergan could benefit from tapering.

Jan 6, 2014 at 8:15PM

The U.S. economy is in better shape than it was a few months back and in even better shape than it was at the start of 2013. Not only is this good news for families across the U.S., but it's also awesome news for growth stocks like Allergan (NYSE:AGN).

That's because growth stocks tend to perform well during the more prosperous parts of the business cycle, when consumer confidence is improving and households across America are spending more and more. In addition, the risk premiums attached by the market to growth stocks like Allergan are also reduced, meaning future cash flows are discounted at a lower rate -- which, in turn, means a higher valuation. This is great news for shareholders.

Of course, not all stocks are affected to the same extent, but the signs appear to be encouraging for Allergan. It is now forecast to deliver earnings-per-share growth of 31% in the year to Dec. 31, 2013, and 14% in the year to Dec. 31, 2014.

This equates to a compound annual growth rate of 22.2%, which marks Allergan as a seriously hot growth stock. Furthermore, if the U.S. economy continues to improve at the rate it's been doing in recent months, upgrades to EPS forecasts could be possible, with a proportion of Allergan's sales being discretionary rather than staples.

This is a point worth noting. Unlike many of its sector peers, which exclusively sell drugs that patients need to get better, Allergan also sells products such as botox, which -- although sometimes needed for the treatment of conditions such as upper limb spasticity -- isn't always a necessity.

Therefore, it could be argued that further improvements in the outlook for U.S. household budgets may mean increased demand for discretionary health-care products such as botox, with Allergan being a possible net gainer.

Of course, Allergan's fundamentals also allow it to hold its own when pitted against sector rivals such as Merck (nyse: mrk) and Pfizer (nyse: pfe). For instance, Allergan's return on equity in 2012 was a very encouraging 18.8%, and with the previously mentioned growth prospects still to come, 2013 and 2014 could be even better.

Allergan's return on equity compares favorably with that of Merck and Pfizer. Their most recent return on equity figures were 11.4% and 11.6%, respectively, although both companies are set to grow earnings at a slightly faster pace than Allergan in 2013 and 2014 (combined), so the gap should narrow somewhat, although Allergan should still be out in front.

Such comparisons highlight the attraction of Allergan as opposed to highlighting the weaknesses of Merck and Pfizer, both of which are exciting pharmaceutical stocks in their own right.

However, it does appear as though Allergan is well positioned to benefit from an improving U.S. economy, having the potential for upgrades to its already highly impressive growth forecasts.

The discretionary nature of its products may also give it a boost as the U.S. economy goes from strength to strength and tapering really takes hold in 2014 and 2015.

Here's another hot growth stock for 2014
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Fool contributor Peter Stephens and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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