High-flying growth stocks might grab all the headlines, but even the best businesses can provide inferior returns if you overpay for them. This is why the world's most successful investors scour the markets for the best value stocks, or those currently trading at a discount to the companies' intrinsic value.
Right now it looks like Berkshire Hathaway Inc. (NYSE:BRK-A) (NYSE:BRK-B), Gilead Sciences, Inc. (NASDAQ:GILD), and Celgene (NASDAQ:CELG) are trading at deep discounts to their intrinsic values. Let's look at reasons these large-cap value stocks aren't getting the recognition they deserve to understand why they can provide a long-term boost to your portfolio.
Value investing built this $293 billion empire
Legendary value investors Warren Buffett and Charlie Munger have built Berkshire Hathaway into a conglomerate with a book value of $292.85 billion as of its last earnings report. That's 66% more than it was worth just five years ago. And the past several years aren't outliers: Since 1965 the stock has enriched its shareholders with average annual returns of 20.8%.
Berkshire Hathaway isn't just a testament to the benefits of buying undervalued companies -- it's a value stock in its own right. While the average stock in the S&P 500 can be purchased for around 3.2 times its book value, Berkshire Hathaway shares are trading at just 1.4 times the company's book value.
On its own, a low price-to-book ratio means little if the underlying business doesn't continue growing. Berkshire rises to the top of this value stock list because the wholly owned businesses and stock holdings in its portfolio all share a common theme. They all have highly durable advantages over their respective competitors that allow them to funnel steady profits to Berkshire's bottom line. For example, it's hard to imagine a smaller competitor investing heavily enough to compete for the freight transported by Berkshire's BNSF railroad.
Owning Berkshire Hathaway also gives you exposure to quality companies in which it holds large stakes but doesn't own outright, such as Apple and Coca-Cola. There are no guarantees the stock will continue delivering annual returns above 20%, but scooping up shares at the recently low price tilts the odds in your favor.
Down but not out
Look all you like, but you won't find a large-cap biotech trading at a deeper discount than Gilead Sciences. At recent prices, shares of the antiviral-drug maker can be bought for just 5.8 times the amount of free cash flow it generated over the past year. Basically, this means that for every $100 invested at recent prices, the business would generate about $17 each year in cash that it can return to you in the form of dividends and share buybacks. This assumption is based on free cash flow remaining flat, which is where things get a bit sticky.
Gilead's largest source of revenue is its lineup of hepatitis C virus (HCV) treatments. Unlike the company's HIV therapies, its HCV treatments cure nearly every patient in a matter of weeks. Now that many advanced-stage patients have been cured, Gilead's HCV franchise sales have been slipping.
Management expects HCV revenue to fall from $14.8 billion last year to between $7.5 billion and $9 billion this year. Sinking HCV sales are troubling, but I still think this is a red-hot value stock. Gilead's HCV treatments have a leading share of the space. An estimated 71 million people carry the disease worldwide, which means, eventually, demand will stabilize.
But Gilead also has a commanding lead in the HIV space, and sales in the indication are growing fast. First-quarter sales of HIV drugs rose about 14% over the previous-year period to a $13.2 billion annualized run rate, and should continue climbing. The company's recently launched treatments are much safer than earlier options, an important feature for drugs that require lifelong dosing.
Less expensive than it looks
At 44.9 times trailing earnings, you might think I'm crazy to suggest Celgene shares are a bargain. But you just need to look at how fast it's growing to see that it's one of the cheapest cancer-drug stocks you can buy right now. In the first quarter, the company recorded $2.95 billion in product sales, which was an 18% increase over the same period last year.
Celgene's growth spurt should extend beyond the most recent quarter. On average, analysts following the company expect earnings to grow by 20.7% per year over the next five years, driven by increasing use of its flagship multiple myeloma therapy, Revlimid.
Looking even further ahead, the company has an oral multiple sclerosis candidate in clinical trials called ozanimod that could generate up to $5 billion in annual sales, if it receives approval by the Food and Drug Administration. The company also boasts a dizzying array of partnerships with smaller biotechs that will keep its development pipeline chock-full of potential winners for many years to come.
To understand why Celgene is a terrific value, we need to compare the stock's current price to its expected earnings growth with the forward PEG ratio. Generally, PEG ratios below 1 suggest a stock is undervalued. Celgene's ultra-low forward PEG ratio of 0.08 tells us that buying now and holding on for the long haul could lead to market-thumping returns.
Cory Renauer owns shares of Coca-Cola and Gilead Sciences. The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), Celgene, and Gilead Sciences. The Motley Fool has the following options: short June 2017 $70 calls on Gilead Sciences. The Motley Fool has a disclosure policy.