This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Terrible Teva
No two ways about it: This week is turning out to be one that Teva Pharmaceutical (Nasdaq: TEVA  ) shareholders would love to forget. On Wednesday, news that the company beat estimates on earnings but missed on revenues -- and declined to give forward guidance to boot -- sent the shares down more than 5%. Adding insult to injury, investment banker Needham & Co. did a quick 180 on the stock yesterday, downgrading Teva all the way from "strong buy" down to "hold."

Needham criticized Teva for its "effective withdrawal of prior guidance" and complained of "disappointing top-line trends" suggesting that Teva might not live up to analysts' hopes for a $5.61 profit this year. Brother banker Canaccord Genuity ganged up on Teva soon after, again highlighting the "lack of guidance update" as reason for concern. Canaccord still thinks the stock is a "buy," mind you. But Canaccord said it preferred rival Perrigo (Nasdaq: PRGO  ) as a "defensive growth" stock, or, even better, Watson (NYSE: WPI  ) as a fast grower with minimal exposure to Europe. (On the other hand, Canaccord still likes Teva better than Mylan (Nasdaq: MYL  ) , another generic player that apparently has too many question marks despite its apparent cheapness.)

Is Teva as cheap as it looks?
But if Canaccord is still optimistic about Teva, despite sharing Needham's reservations over the lack of earnings guidance, why is it that Needham has chosen to downgrade the stock, but Canaccord, not? After all, even Needham admits that Teva today sells for a "historic low valuation," and one that "largely discounts secular growth concerns." And worst-case, Needham thinks there's only 10% to 15% "downside" in the stock at today's prices, "even in the event of a negative outcome in patent litigation against generic Copaxone filers."

The real problem, it seems, is Needham's worry that the upside at Teva is similarly limited. But is it, really?

Consider: In a recent column comparing Teva with other mass producers of pharmaceuticals, The Wall Street Journal observed that Teva filled "U.S. prescriptions ... at a rate of 1,052 a minute last year." The Journal added: "That is more than twice the pace of Pfizer (NYSE: PFE  ) Inc, the world's largest drug maker by sales."

Yet if you examine the valuation at Teva, this stock looks far cheaper than Pfizer. Teva's forward P/E ratio of 6.9 is lower than Pfizer's 9.7. (It's lower, too, than the forward P/Es on any of the aforementioned generic-drug companies.)

Sure, there's a risk that Copaxone patent protection will end early. But that's hardly an uncommon concern in the drug space, and for Pfizer in particular. Even in the best case, Teva only expects to be able to keep exclusive rights to manufacture Copaxone through 2015 or so, meaning those revenues -- roughly 20% of Teva's total revenue stream -- are due to disappear soon in any case. Seems to me the real key here is that after Teva loses its patent protection on this drug, it still has 1,300 other generic drugs it produces to draw revenues from, with 180 more drugs pending FDA approval.

Foolish takeaway
Worst case, even without specific guidance from the company, most analysts think Teva should be able to maintain 8.5% long-term earnings growth. On one hand, this looks a bit slow in light of Teva's 13 P/E ratio today. On the other hand, Teva just finished growing revenues 25% year over year last quarter, and adjusted earnings 41% on a per-share basis.

Given this performance, do you think Wall Street's 8.5% growth estimate might be just a wee bit conservative? I do, and I've rated Teva an "outperform" in my CAPS portfolio because of it. Will the pick work out? Follow along, and feel free to jeer if it turns out I'm wrong. And if you do think I'm wrong, and are looking for other pharmaceutical ideas, read the Fool's new report, "Secure Your Future With 9 Rock-Solid Dividend Stocks," where we name two other pharma stocks with great dividends, and a bit less "excitement" than Teva provided this week.

Fool contributor Rich Smith owns no shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 330 out of more than 180,000 members. The Motley Fool has a disclosure policy.

Motley Fool newsletter services have recommended buying shares of Teva Pharmaceutical Industries and Pfizer.  We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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