Investment Consult

3 bargain stocks to grab and hold

Despite some tough challenges, the pharmaceutical industry still presents good investment opportunities.

Lewis J. Altfest, PhD, CFA, CFP

These are rocky times for drug stocks. Patents for certain high-profile drugs, such as Prozac and Claritin, have either expired or soon will, leaving them vulnerable to generic drug makers. Smaller and nimbler biotech companies are competing for the same patients, and fewer potential blockbuster drugs await FDA approval.

As a result, the pharmaceutical industry's annualized three-year total return is 1.6 percent, according to Morningstar, the Chicago-based investment tracker. While that's better than the average three-year annualized return for the S&P 500 (minus 7.8 percent), it lags way behind biotech's healthy average of 12.8 percent a year.

Although the biotech industry includes some excellent companies, I believe many biotech stocks are overpriced. Several traditional "big pharma" firms, on the other hand, are beaten down and have below-market price-earning ratios, indicating that they may be undervalued.

Some believe big pharma's ready for a resurgence. The Value Line Investment Survey estimates that the drug industry, independent of biotech companies, will produce a 29 percent average annual return on shareholder equity over the next five years.

Investors have to be more selective than ever in choosing which drug stocks to own. With this in mind, let me present my case for Bristol-Myers Squibb, Merck, and Schering-Plough. Each has problems, but if you remain patient and hold any of them for at least two years, you could potentially earn 50 percent or more on your investment.

Bristol-Myers Squibb. When this column went to press, Bristol-Myers Squibb was selling at 25, below its previous five-year low. On May 3, the company was hit with a class-action lawsuit charging that it overstated or misled investors regarding its income, sales, and earnings growth. Previously, the company faced a setback when the FDA rejected the application for Erbitux, a cancer drug it's marketing in partnership with ImClone Systems—a company that has received some notoriety because of allegations of insider trading involving its founder. Combine the rejected application with the loss of patent protection for three of its brands—BuSpar, Glucophage, and Taxol—and it's no wonder Bristol-Myers Squibb has been the subject of takeover rumors.

The company still has heavy hitters. Cholesterol-fighter Pravachol and anticoagulant Plavix continue to sell very well. So do over-the-counter remedies Bufferin and Excedrin. In addition, Bristol-Myers Squibb took steps last year to refocus on drug products by spinning off its orthopedic implant business, buying DuPont's pharmaceutical unit, and selling hair care company, Clairol.

Despite its current difficulties, Bristol-Myers Squibb is severely undervalued: Its price-earnings ratio is less than half the average for its industry. As for takeover rumors, they're probably unfounded. With a value of $49 billion, the company would be affordable to only a precious few.

I think Bristol-Myers Squibb will rebound strongly, and its stock price could double within a few years.

Merck & Co. Like Bristol-Myers, Merck's research and development pipeline has been dry of late. In addition, sales of Prinivil and Prilosec, a joint venture with AstraZenaca, are expected to suffer when the company's patents on them expire later this year. That's on the heels of the stock's negative 36 percent return in 2001.

Although the stock may tread water this year, not all the news is bad: Sales on five of Merck's key products—Cozaar/Hyzaar, Fosamax, Singulair, Vioxx, and Zocor—jumped 23 percent over 12 months, to $3.7 billion, and sales should continue to rise overall. In fact, Merck's total annual sales have increased every year since 1992, and were $47 billion for 2001.

In 2003, management plans to spin off Merck-Medco Managed Care, its pharmacy benefit manager. This removes any potential conflicts of interest and allows Merck to shed a low-profit business. I expect Merck's earnings to increase 10 percent next year—and possibly more if the overall stock market beats expectations.

Schering-Plough. This company is best known for its prescription antihistamines Claritin and Claritin-D, which last year accounted for more than $3.1 billion in sales. It also produces and markets consumer products, including Dr. Scholl's and Tinactin for foot care, and Bain de Soleil and Coppertone sunscreens.

With Claritin scheduled to come off patent in December, Schering-Plough applied with the FDA to have all five formulations of Claritin converted to over-the-counter status. That filing, which the FDA is expected to act on in November, would go a long way toward helping the company fend off competition from generic versions of Claritin.

Schering-Plough's stock price has taken a beating over the past 18 months, but I think the worst is over and that the company will recover nicely going forward.

The author, a fee-only financial planner, is president of L.J. Altfest & Co. ( www.altfest.com ), a financial and investment advisory firm in New York City. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also send a fax to 201-722-2688 or e-mail to meinvestment@medec.com.

Lewis Altfest. Investment Consult: 3 bargain stocks to grab and hold.

Medical Economics

2002;14:18.