Sky-High Drug Stocks May Not Be Safe Havens
By Lawrence Strauss
09/23/98
Dow Jones News Service
Barron's Online
NEW YORK (Dow Jones)--In bull markets and bear markets, recessions and booms, people get sick.
And that, in a nutshell, is the rationale for buying drug stocks these days.
Drug stocks have held up well amid this summer's big selloff. As of Tuesday's close, the Dow Jones Pharmaceuticals group was off only 3.5% from the July 17th market peak, compared with a 13.2% decline in the S&P 500. And since mid-summer, the drug stocks have been less volatile than other sectors.
No doubt, there's plenty for investors to like: consistent, double-digit earnings growth; industry consolidation; a strong pipeline of new products, and relatively little exposure to economically troubled emerging markets. Many analysts think companies like Merck & Co. (MRK) and Pfizer Inc. (PFE) are good bets to continue growing their revenues and earnings handsomely.
Richard Vietor, who tracks the major drug makers for Merrill Lynch, has a typically bullish view on the sector: "Their earnings are much more likely to come through than other sectors," he argues--especially in uncertain economic times.
But these stocks may not turn out to be the safe haven investors have been seeking. In particular, their current valuations look rich compared with the market as a whole. Stefan Loren, an analyst who tracks the major drug makers for Legg Mason, believes the expensive premiums these companies command are justified. But that could change in a heartbeat, he admits. "It's hard to say how long they can sustain these kind of multiples," he says.
A generally bullish August report by Dresdner Kleinwort Benson North America LLC also noted that "rich valuations are a concern." As of this week, drug stocks as a group traded at a P/E multiple of 32 times next year's projected earnings. That's more than double their norm of 15.5x for the last 22 years and more than a 50% premium to the S&P 500, which as of Tuesday was trading at nearly 21x next year's earnings. (That compares with a 16-year historical average premium to the S&P of only 16%.) Plus, the sector's P/E is around 2.5 times its long-term growth rate, more than double the historical average.
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