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Follow Warren Buffett Into These 3 Pharma Companies

By Anirudh Shankar - Apr 14, 2021 at 7:13AM

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See why the world's most acclaimed value investor is investing in these three stocks.

Warren Buffett is regarded as one of the world's quintessential value investors. Following the teachings of his business school professor Benjamin Graham, Buffett has made a legendary career for himself by buying companies for less than what he sees as their true value. He recently made purchases of three large-cap pharmaceutical companies, AbbVie (NYSE: ABBV), Bristol Myers Squibb (NYSE: BMY), and Merck (NYSE:MRK). Let's explore the ways they offer a great opportunity for everyday investors, too. 

A bull vs. a bear

Image source: Getty Images.

Picking up a fast grower

Spun off from Abbott Labs in 2013, AbbVie is one of the newer pharmaceutical companies on the market. However, the young company's management team wasted no time developing breakthrough drugs and driving sales to generate huge returns for shareholders. One of its more recent successes, Humira (for Crohn's disease), was the world's best-selling drug in 2020, with revenue of nearly $20 billion. This and several other leading products, including Skyrizi (for psoriasis) and Rinvoq (for rheumatoid arthritis), have helped drive AbbVie's stock price up nearly 228% since inception. 

In today's market, overvaluation is the norm. But this stock proves that there are still bargains to be found. It generates tremendous cash flows and offers a 5% dividend yield to reward investors. Buffett likes buying undervalued equities, and at a price-to-earnings ratio of 8.55  (compared with its historical average of about 13), AbbVie is currently on sale. This stock satisfies investors with a variety of goals. Whether you want to beat the market or add extra dividend income, AbbVie is the stock to buy.

Bristol Myers Squibb's on sale

The 134-year-old Bristol Myers Squibb picked up a set of fresh legs starting with its late 2019 acquisition of Celgene, which has bolstered its pipeline of new drugs. As soon as that $74 billion acquisition had concluded, management announced they would be spending another $13.1 billion to buy MyoKardia . The market is pricing in a lot of downside for the stock because of the risks associated with paying off the debt that financed these acquisitions, but when we look at the long term, the benefits are likely to set Bristol Myers Squibb apart as a strong player in the healthcare space. 

Bristol Myers Squibb has been beaten down lately, trading at a price-to-earnings ratio of 8.27 compared with a historical average of about 18. Current estimates for forward earnings per share are about $8 -- if we multiply that by 18, we can see the potential for about a $135 stock price from the current $63. I don't expect a return to fair valuation to happen overnight, but in the meantime, the stock offers a 3.17% dividend yield, and the recent dividend hike of 9.4% suggests that management is confident in generating more cash flow to disperse to shareholders.

Adding safety and security

Founded in 1668, Merck is one of the oldest pharmaceutical companies in the world. The small hiccup in the stock price that has put the stock on sale today should not be seen as a deterrent. Instead, it's a great opportunity for long-term investors to acquire the stock and watch its price rise. When you put money into a stock, you're buying part of a business -- and in Merck's case, that business is thriving. Cash flow looks great, with year-over-year earnings-per-share growth of 14.4% from 2019 to 2020. Sales growth for Keytruda (which treats cancer) and Gardasil (a vaccine against human papillomavirus) was 28% and 44%, respectively, in just the most recent quarter!

At its current forward price-to-earnings ratio of just 11.5, Merck trades at almost a 25% discount to its historical levels of about 16. If you take the latter figure and multiply it by the forward earnings estimate ($6.51), we are looking at a stock price of about $105 -- a 38% upside from here.

Three undervalued plays with little downside

When Warren Buffett invests in stocks, he looks at something called a margin of safety -- the difference between a company's current price and its average market valuation. Declining or stagnating stock prices can suggest to investors that something is wrong with a business, but it's also possible that the market has simply mispriced a stock, making for a great opportunity to pick up shares on the cheap.

All three of the companies above offer dividend yields higher than 3%, with AbbVie yielding near 5%, and all have been raising their dividends consistently and substantially. Investing for the long run takes patience; Buffett himself has been famously quoted saying "Nobody wants to get rich slowly." But his purchase of these three stocks is a classic example of playing the long game. And if Buffett can get rich that way, so can you.

Anirudh Shankar owns shares in AbbVie, Bristol-Myers Squibb, Merck, and Johnson & Johnson. The Motley Fool recommends Johnson & Johnson. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Merck & Co., Inc. Stock Quote
Merck & Co., Inc.
MRK
$89.48 (-0.04%) $0.04
Bristol Myers Squibb Company Stock Quote
Bristol Myers Squibb Company
BMY
$74.27 (-0.92%) $0.69
AbbVie Inc. Stock Quote
AbbVie Inc.
ABBV
$139.90 (-0.25%) $0.35
Johnson & Johnson Stock Quote
Johnson & Johnson
JNJ
$170.71 (0.31%) $0.53
Abbott Laboratories Stock Quote
Abbott Laboratories
ABT
$110.10 (2.03%) $2.19

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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