How Cheap Is Teva?

Numbers can lie -- but they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

  • The current price multiples.
  • The consistency of past earnings and cash flow.
  • How much growth we can expect.

Let's see what those numbers can tell us about how cheap generic drug maker Teva Pharmaceutical (Nasdaq: TEVA  ) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the price-to-earnings ratio. It divides the company's share price by its earnings per share -- the lower, the better.

Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). Like the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

Teva has a P/E ratio of 19.4 and an EV/FCF ratio of 15.9 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Teva has a P/E ratio of 34.2 and a five-year EV/FCF ratio of 24.0.

A one-year ratio under 10 for both metrics is ideal. For a five-year metric, under 20 is ideal.

Teva is 0 for 4 on hitting the ideal targets, but let's see how it compares against some competitors and industry mates. 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

Teva Pharmaceutical Industries

19.4

15.9

34.2

24.0

Abbott Labs (NYSE: ABT  )

15.4

12.1

20.6

17.9

Albany Molecular Research (Nasdaq: AMRI  )

NM

24.0

71.9

17.8

Elan (NYSE: ELN  )

NM

28.8

NM

NM

Source: Capital IQ, a division of Standard & Poor's; NM = not meaningful.

Numerically, we've seen how Teva's valuation rates on both an absolute and relative basis. Next, let's examine ...

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash flow generation.

In the past five years, Teva's net income margin has ranged from 0.8% to 21.3%. In that same time frame, unlevered free cash flow margin has ranged from 13.4% to 23.1%.

How do those figures compare with those of the company's peers? See for yourself:

Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.

Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.

Additionally, over the last five years, Teva has tallied up five years of positive earnings and five years of positive free cash flow.

Next, let's figure out ...

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared to similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. In that time period, Teva has put up past EPS growth rates of 14.5%. Meanwhile, Wall Street's analysts expect future growth rates of 13.3%.

Here's how Teva compares with its peers for trailing five-year growth (Albany's and Elan's aren't meaningful because of negative earnings):

Source: Capital IQ, a division of Standard & Poor's; EPS growth shown.

Source: Capital IQ, a division of Standard & Poor's; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:

Source: Capital IQ, a division of Standard & Poor's; estimates for EPS growth.

Source: Capital IQ, a division of Standard & Poor's; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us how cheap shares of Teva are trading, how consistent its performance has been, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at a 19.4 P/E ratio. Still, the numbers are just a start.

Although Teva isn't screamingly cheap on a valuation basis, its past and future growth make it a company worth looking into.

If you find Teva's numbers compelling, don't stop. Continue your due diligence process until you're confident that the initial numbers aren't lying to you.

Click here to add Teva to My Watchlist, which will then help you find all of our Foolish analysis on this stock.

Anand Chokkavelu doesn't own shares in any company mentioned. Elan is a Motley Fool Rule Breakers selection. The Fool owns shares of Teva Pharmaceutical. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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