Teva Pharmaceutical Industries (Nasdaq: TEVA ) has been gathering dust on my watchlist for a while. I like the business, I've been drawn in by the shrinking valuation, and while the dividend isn't huge, the company has been growing it very fast. But I just haven't pulled the trigger.
And I'm not the only one that's a fan. The stock is a recommendation of The Motley Fools Global Gains service, and The Motley Fool owns shares after my fellow Fool Jim Mueller gave it a big thumbs-up late last year.
So how do I finally decide whether to buy? I'll take a look at the kind of returns I can expect from the stock.
As I outlined in a previous article, a good way to get a baseline for growth expectations is to check on what Wall Street analysts expect and how fast the company has actually grown in the past.
Annual Growth Rate
|Last 12 months||48%|
Source: Capital IQ, a Standard & Poor's company. Historical growth based on earnings per share. *Through 2010.
There are a couple of immediate takeaways here. First, that's some pretty healthy growth. Second, the past 12 months aside, the rate of growth has been slowing, and the growth expectations of analysts underscore that.
But there are a few things to consider that aren't reflected in the company's historical growth. Chief in investors' minds is the expiration of the patents for Copaxone, which is a proprietary treatment for multiple sclerosis that brought in $3.3 billion in revenue in 2010. That's a hefty chunk of Teva's total revenue and likely an even bigger chunk of its profits since proprietary drugs tend to be so profitable.
Additionally, just last month Teva agreed to buy Cephalon for $6.2 billion. The deal is expected to be immediately accretive to Teva's non-GAAP earnings and provide $500 million in synergies by year three. It also could lessen the concerns about Copaxone because it brings in Cephalon's proprietary drugs and its pipeline. On the flip side, investors will now have a slate of Cephalon drugs that they can worry about, including top-selling Provigil, which loses patent protection next year.
In light of all of this, I'm willing to consider analysts' 11% per-year growth as the top end of my expectations. However, for my base case I went with 5%, which I believe allows for moderate growth and very healthy downside protection for the Copaxone issue. And on the lower end, I cut the rate down a bit more to 3%.
Pinning down valuation
Valuations are a moving target that can be tough to predict, but, as with growth above, using a range of values can give us a view of our potential returns without requiring a Miss Cleo-type prescience.
In creating our range, a good place to start is where the stock is trading right now and what its historical trading range has been. Right now, Teva's stock changes hands at 13.4 times trailing earnings. This is all the way at the lower end of the range for the stock as its annual average earnings multiple was generally in the 20s and 30s during the stretch between 2000 and 2010.
For broader context, we can also look at how similar companies trade.
|Bristol-Myers Squibb (NYSE: BMY )||12.5||1%|
|Eli Lilly (NYSE: LLY )||9.5||(7%)|
|Forest Laboratories (NYSE: FRX )||10.3||(3%)|
|Pfizer (NYSE: PFE )||9.3||3%|
|Abbott Laboratories (NYSE: ABT )||10.9||9%|
|Celgene (Nasdaq: CELG )||16.6||23%|
Source: Capital IQ, a Standard & Poor's company.
What's notable is that with the exception of Abbott and Celgene, all of the companies above are expected to either grow at a snail's pace or shrink. And that makes sense considering the fact that many of these companies -- particularly Eli Lilly and Pfizer -- are far more dependent on proprietary drugs than Teva and are facing major patent expirations in the coming years. With that in mind, it seems a little silly that Teva's stock is trading at just 9.2 times its expected forward earnings.
Putting on my rose-colored glasses, I could see investors paying as much as 20 times earnings for Teva's stock if the company performs well and the market gets some pep back. More likely, I think the earnings multiple (on a trailing basis) will creep up to 15. On the downside, I cut the multiple from its current level to 12.
Dividends and share count
Our final stop is to consider how much we'll get paid through dividends and whether changes in share count will affect our bottom line.
Teva has a history of diluting its shareholders by growing its number of shares outstanding. Over the past decade, the share count has grown an average of 5.7% per year, and though that's slowed in recent years, it's continued to grow. Since the historical growth numbers I provided above were on a per share basis, it shows that the company has been able to notch significant growth for shareholders even as the share base has grown. That said, the share count will be something for investors to keep an eye on.
On the flip side, Teva has grown its dividend very quickly, which is something I like very much. Though the 1.9% current yield isn't particularly eye-catching, the company's 10-year average dividend growth has been 29%. That growth has slowed a bit, but over the past three years it's still been 23%.
Since Teva also has a low payout ratio, I felt comfortable assuming that its annual dividend growth would fall somewhere between 15% and 22% over the next five years with a most likely rate of 20%.
The verdict please!
The end result of all of this is the returns we can expect under the various scenarios. Here's what my three scenarios would look like.
Annual Earnings-per-share growth
Annual Dividend Growth
Expected Annual Returns
Source: Author's calculations.
Let's now go back to that question that we started with: Could Teva's stock offer a 100% return?
Under the optimistic case, the answer is a very definite "yes." Using those assumptions, the stock would actually get you close to a 200% return over the five-year period. You don't quite get there with the base case, but a 63% return isn't too shabby either.
So will Teva get out of my dreams and into my portfolio? I think it will. I ideally like to look for expected returns of 12% or better, but given the conservative growth I've used for my base case I feel like I've given the stock plenty of room to exceed my expectations.
Of course the future is an ever-changing picture, so you need to keep on top of what's going on at Teva to see which set of numbers the company and stock are able to live up to. And you can do just that by adding the stock to your Foolish watchlist.