Over the long term, stock prices follow the ability of a business to generate profits. That can easily be forgotten when fast-growing, money-losing companies are doubling in price as they go public, or climb 100%, 500%, or even 1,000% in a year. The stock prices of these companies can fluctuate wildly because they are based on assumptions about growth with little history to go on, and those assumptions can change rapidly.
For mature businesses that have consistent earnings, like Pfizer (PFE +0.33%), it's easier to estimate how much the company might earn in the future. Using its long history, we can even come up with a range of possible stock prices years from now and whether the implied returns would make it a good investment.
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Putting a price on profits
Earnings are simply what's left over from the company's sales after accounting for all the costs associated with making a product or service and running the business, as well as expenses like taxes and interest on debt. Investors will pay a multiple of those earnings, represented by the price-to-earnings ratio (P/E), depending on how optimistic they are about the future of the business. A higher P/E ratio usually implies a higher expected growth rate. For instance, the historical P/E ratio for the S&P 500 index is about 16, but it rose as high as 44 at the end of the dot-com bubble. Today, the measure sits at about 39.
For an individual stock, looking at this ratio over time can give us a sense of what P/E ratio the market may settle on if the company's earnings can be estimated. Of course, predicting the future can also be a fool's errand. Luckily, Pfizer CEO Albert Bourla recently provided analysts with guidance that could help make estimation easier. At the JPMorgan Healthcare Conference earlier this month, Bourla reiterated company guidance for sales growth of at least 6% through 2025 and implied that earnings will grow double digits, meaning 10% or more, through the end of the decade. No doubt having a vaccine for COVID-19 bolstered the outlook, but it also added some uncertainty.
Historical multiple
Pfizer's average P/E ratio over the past five years is 20, ranging from 11 to 32 over the past decade. The current price is about 16 times estimated 2020 earnings. Since the market is willing to pay a higher multiple for faster growth, Pfizer's recent spinoff of the slower-growing Upjohn unit into Viatris (VTRS 1.75%) might help Pfizer garner a premium to its current valuation in the years ahead.
If we assume the P/E ratio of 16 to 20 is a good estimate, and the CEO's projections are on the mark, we can calculate the likely price of the stock in a decade using the company's guidance for $3.05 earnings per share (EPS) for 2021. From there, we can back into the rate of return and how much would need to be invested to end up with $1 million.
Here are the 10-year calculated returns based on the estimates:
| P/E Ratio | With 10% EPS Growth | With 11% EPS Growth | With 12% EPS Growth |
|---|---|---|---|
| 16 | 247% | 280% | 315% |
| 18 | 290% | 327% | 367% |
| 20 | 333% | 375% | 419% |
Data source: YCharts. Table by author.
Using the inputs, we can see that the likely range of returns from buying Pfizer stock right now is between nearly 250% and 420% over the next decade. So, to end up with $1 million in 10 years, you would need to invest somewhere between $239,000 and $404,000. For comparison, the S&P 500 has returned an average of 8% per year since it adopted its current form in 1957. That equates to 216% over the average decade. Add in dividends, and Pfizer yields 4.3% compared to the S&P 500's 1.5% -- and it gets even easier for Pfizer to beat the market and be a millionaire-maker stock.
Diversification
Of course, you wouldn't want all of your eggs in one basket. Bourla's projections could be wrong, or the market could decide to place a much lower multiple on earnings for any number of reasons. Pharmaceutical companies always face the risk of failed drug trials, and despite persistently low inflation over the last few years, high-yield stocks like Pfizer typically perform poorly when inflation ramps up.
That's why almost every financial advisor recommends a diversified portfolio of assets, including stocks from different industries. That said, based on Pfizer's typical P/E ratio and the CEO's recent projections, the stock appears to offer a significantly better potential reward than the overall market typically does. Investors looking to add a high-yield drugmaker to their portfolios should consider adding Pfizer for its potential over the next decade.
