In his book Buffett: The Making of an American Capitalist, Roger Lowenstein quotes from a letter Warren Buffett wrote to his partners in 1963:
"This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results."
As with so much that the Oracle of Omaha has done with investing, this philosophy stands on its head the traditional way that most investors look at their portfolios. Rather than concern yourself so much with the price at which you'll sell your stock, consider more closely how much it will cost you to buy it. Getting a good company at a great price relieves you of a lot of pressure of hoping your stock rises in value.
I've gone from being a momentum buyer of growth stock to someone who follows a more value-oriented philosophy. I probably haven't gotten to where I could assume the helm of Inside Value from Philip Durell just yet, but Tom Gardner has certainly weaned me from the go-go style I use to favor, so that now I look for small caps being offered at a discount, such as those highlighted each month in Hidden Gems.
Finding that discounted stock often requires that we look for a good company that's gone through some pain recently. Some say I've derived too much pleasure from chronicling the foibles of Chiron
Chiron's earnings report is out, and the results are much worse than anticipated. It announced that it lost $22.9 million in the fourth quarter, or $0.12 per share, compared with a profit of $121.8 million in the same period last year, or $0.61 per share. The company also wildly missed analyst estimates of $0.10 per share in earnings.
The stock, which fell a little over 1% today following the earnings release, sits some 26% below where it was when the vaccine crisis hit. But again, is it one of those classic Buffett-Ben Graham "cigar butts"? Having gone as low as $29 a stub, Chiron lost over $3 billion in market cap. Even at today's prices, the company has lost more than $2 billion in value. With revenues from all segments last year totaling just $1.8 billion and the Fluvirin vaccine alone amounting to just $300 million in sales, this certainly looks like a case of investor overreaction.
Yet maybe its prior valuation was an example of investors being overly exuberant.
Excluding Fluvirin, product sales increased 13% for the year. Gross margins were at 47%, down from 58% last year because of the loss of the profitable vaccines. Yet going forward, the company expects its products to sell from the high single digits to the mid-teens for its nucleic-acid tests. If we assign an average growth rate of 10% to these product sales, we'd have around $2.13 million in revenues three years out. With net profit margins around 9%, we'd have earnings slightly north of $191 million, or about $1.03 per share. Even though it has generally sported a price-to-earnings ratio well over 40 for the past decade, that was including the prospects for future vaccine sales. If we knock that market multiple in half, to about 20 or 25, that gets us a price range of $20-$26 a share in 2007.
Not exactly a bargain just yet, but a lot could change that outcome. If flu-vaccine sales get back on track, that might add another $500 million or so in sales and could tack on an additional $0.24 per share in earnings. It would also probably warrant a slightly higher multiple, but its current price would still be only fairly valued three years out. It would also take a lot to work off its current enterprise-value-to-free-cash-flow ratio of 72.
There's still too much fog in front of Chiron to see too far ahead. While the company has been buffeted by the winds of this vaccine disaster, it's still a viable business with successful products to sell. It's just not particularly cheap right now -- it doesn't have that Warren Buffett low-price cornerstone he looks for -- so I wouldn't be stooping over to examine this cigar anytime soon. It has way too many puffs left on it.
Read all about how Chiron got into this condition:
- Chiron Sneezes, Investors Catch Cold
- Chiron Crisis Creates Investor Opportunity
- Regulators Quarantine Chiron
- Chiron's Earnings Ills
Check out Inside Value for companies that are selling at a real discount to intrinsic value. There's a 30-day free trial.