Investors in the pharmaceutical industry have reason to kick back and enjoy their summer vacations this year. The stocks in this industry have seen market-trouncing returns, with the S&P Pharmaceuticals Select Industry Index up 16.5% while the S&P 500 has grown less than 1% on a year-to-date basis.
But with the healthcare sector in a multi-year-strong up-trend, many investors are nervous. Isn't it time to think about selling rather than buying?
Actually, I believe now is a great time to buy several pharmaceutical stocks. Let me explain. Historically, pharmaceuticals have been the ultimate buy-and-forget stocks. But the ongoing expiration of patents on key drugs has Wall Street less than enthusiastic about certain Big Pharma names, such as Merck (NYSE:MRK).
The upshot is that you can get some of these at prices far below what they may be worth. Merck, for instance, now trades for 15.3 times next year's estimated earnings. That's well below the price/earnings multiple of the S&P's 500 index. And it's despite Merck's historical norm of trading at a 15% premium to the market.
I'd say the chances of Merck returning to its historical norm are high, since its pipeline now contains some very promising drugs. Looking beyond Merck, an abundance of recent monster-sized mergers have beefed up pipelines and reduced heavy research costs for several other "hidden in plain sight" pharmaceutical companies as well.
Here are five pharmas that I think are good for the long haul. Most are tried-and-true favorites, but expect a few surprises along the way.
Johnson & Johnson scoffs at the patent cliff
It's more than a little cliché, but that doesn't mean that Johnson & Johnson (NYSE:JNJ) doesn't belong on a list of the five best pharmaceutical stocks. While it has long been known as a great buy-and-hold-forever stock, significant momentum in its pharmaceutical business is making J&J especially attractive right now.
While some analysts have been focusing on declining Olysio, Remicade, and Zytiga sales, J&J has been notching remarkable gains through its new drugs. Last quarter, sales of diabetes drug Invokana tripled year-over-year to $278 million. Sales of broad-based cancer drug Imbruvica also soared. In fact, overall, the pharma giant saw pharmaceutical sales grow 10.2% on an operational basis last quarter.
Better yet, J&J has a mountain of cash, so it may soon decide to join the M&A frenzy in healthcare. A buyout could give its already wide and deep pipeline even more zing. And the 3% dividend, which ticks upward like clockwork every year, is pretty nice, too.
Lannett Company looks super-cheap
Seeing a mid-cap generic drugmaker on this list may surprise you, but Lannett Company (NYSE:LCI) looks like a real bargain right now. Despite beating earnings last quarter, a revenue miss tumbled the stock and brought the earnings multiple down to 15.
Lannett's management raised its guidance last quarter. The gross profit margin for Lannett leapt upward last as well, coming in at 77.08%. The net profit margin was also above the industry average at 39%.
While mid cap stocks tend to be riskier than large caps, the upside is they can provide higher returns. Lannett has a lineup of successful generic drugs for everything from thyroid deficiency to cardiovascular disease. And, as Motley Fool contributor George Budwell pointed out, Lannett is shifting to controlled substance drugs that carry higher gross margins. The company plans to receive at least 50% of total revenue from these drugs within five years.
Valeant Pharmaceuticals is on the prowl again
A bet on Valeant Pharmaceuticals (NYSE:BHC) is (to some extent) a bet on hedge fund superstar Bill Ackman. Valeant is Ackman's biggest holding. In total, Ackman's Pershing Square owns about 5% of the company.
Rumor has it that Ackman has had Valeant on the prowl for another acquisition, this time animal health business Zoetis, in which he has a 10% stake. If that's so, a megadeal may be on the horizon.
While CNBC tossed cold water on that rumor, tanking Zoetis' shares last week, I'm still optimistic. And even without a buyout, Valeant is firing on all cylinders. In 2015, the company expects outperformance in the United States to offset a foreign exchange impact. At this point, Valeant looks overvalued, with a P/E ratio of 28, but the drugmaker is expected to ramp up its earnings this year by nearly 200%, driving its forward P/E down to 21.
While there's no denying this stock faces challenges, full-year revenue jumped tenfold between 2009 and 2014 to $8.26 billion. This company has been an amazing growth story, but its debt levels are high, and it's the riskiest stock of this bunch in my view.
Merck's pipeline is pumping
This pharmaceutical giant's product pipeline is stocked with drugs for cardiac diseases, hep-C, and cancer. With so many new revenue streams approaching the market, those drugs should prove to be the perfect tonic for the nation's second-largest drugmaker's return to healthy growth.
While it's been in a slump, Merck has a strong long-term history of producing innovative drugs. It also recently released Keytruda, a PD-1 inhibitor that marks a huge stride forward in tough-to-treat cancers. As I predicted back in February, the drug outperformed Bristol-Myers' Opdivo in sales. It's still early days, but Keytruda is on track to hit blockbuster status, perhaps reaching $3.7 billion annually. An Alzheimer's drug, MK-8931, is also in late-stage testing.
Wall Street's loss of confidence in Merck left the shares flat for the past 12 months. I've never owned Merck, but given the pipeline's potential, I'll likely be buying a tiny piece of its future soon.
Allergan as audacious as ever
In March, Actavis PLC gobbled up Allergan (NYSE:AGN) and its blockbuster brand drug Botox in a $70.5 billion deal. The combined company has since changed its name to Allergan. $1.8 billion in synergies should result.
Allergan expects total revenue of $15 billion this year, up from $13 billion in 2014. CEO Brent Saunders has also set an audacious goal of generating "organic revenue growth at an annual growth rate of at least 10% for the foreseeable future."
But is it achievable? Allergan recently made a super-smart acquisition with Kythera Biopharmaceutical, further cementing its position in facial aesthetics. Few competitors match Allergan's product portfolio, which includes biosimilars and complex generic products like Advair. Botox is also seeing rapid label expansion -- the neurotoxin has 90 additional new uses, with patents pending. Add in a recently launched version of generic OxyContin, and I'd say... yes.
Do your due diligence
While these five stocks look well positioned to bring a sizable share of rewards in the long haul, none of these names is bulletproof, so be sure to do your homework. The way I see it, J&J and Merck look super-safe right now, and Lannett at these levels is tempting, but Valeant and Allergan are riskier bets.
Cheryl Swanson owns shares of Johnson & Johnson and Allergan. The Motley Fool recommends Johnson & Johnson and Valeant Pharmaceuticals. The Motley Fool owns shares of Valeant Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.