Stock Evaluation of Pfizer Inc - Assignment Example

? STOCK EVALUATION Introduction The company chosen for stock evaluation is Pfizer Inc., which is an American MNC whose headquarter is located in New York City, founded in 1849. It is a research and development, global pharmaceutical company that operates in five major segments – Animal Health and Consumer Healthcare, Emerging Markets, Specialty Care, Primary Care. The company specializes in animal and human micro molecule vaccines and medicines along with a range of diversified consumer healthcare and nutritional products. Its products are targeted for a wide range of conditions including oncology, cardiovascular and metabolic diseases, immunology, pain and neuroscience, cholesterol, anti-fungus, etc. The company’s stocks are traded at New York Stock Exchange and it also forms one of the companies in Dow Jones Industrial Average, and the S&P 500. The company’s total revenue for the year 2011 was over USD 67.41 billon with a net operating income and net income of USD 12.75 billion and USD 11 billion respectively. Its total asset and equity for the year 2011 was USD 189 billion and USD 81.19 billion respectively. Between the year 2000 and 2011, the company has regularly paid dividends to its shareholders, quarterly, with Average dividend of 0.19, Maximum dividend of 0.32, and Minimum dividend of 0.09. Economic Analysis The State of Overall Economy The economic analysis of a business comprises of analyzing not only the fundamentals of the business, but the overall Macro-economic as well as Micro-economic factors. It is also known as the top down approach because a stock analyst observes the macro and micro economic variable like, GDP, inflation rate, Repo rates, Interest rates, consumer spending, various indices, political and economic stability, government policies, competitors, industry performance, etc. to judge the overall state of business, by analyzing first the Macro factors and then the micro factors – industry and competitors and then the company. Some Key Economic Variables Gross Domestic Product – GDP is defined as the sum of total cost of all goods and services produced in a country for a period of time. The higher the value, the better it is for the economy to expand in future. Interest rates – It is rate at which the Central banks and other commercial banks purchase currency. It has direct impact on the consumer borrowing and lending. So, the lower rates encourages more borrowing and consequently creating more jobs and leading to economic growth. Consumer spending – It depends on the fiscal budget prepared by the government every year. The budget allocated to each sector of economy determines the retail prices, which is higher than wholesale prices. Thus, consumers will be encouraged to spend more when retail prices for the goods and services are lower. Higher spending will create more demand and more jobs that will expand the growth of economy and increase the GDP. Inflation – It is condition when the overall prices goods and services increases due to various reasons including demand-supply mismatch, increased government spending, etc. High inflation rates reduce the real value of money and hence low inflation rates are favorable for economic prosperity. Industry Analysis Nature of Industry The nature of the pharmaceutical industry is that this industry develops or produces and markets generic or branded drugs with the license for the use in various medicines. The most important part of this industry is the Drug License Authority that clears drug licenses of the companies belonging to the industry and the drug patenting. The regulations regarding testing, efficiency, patents, marketing of drugs is guided by the Food and Drug Administration in the United States. Major Competitors Some of the major players in the industry are GlaxoSmithKline, Pfizer, Abbott Laboratories, and Eli Lilly. According to a study conducted in 2008, Pfizer topped the list of pharmaceutical companies all over the world and emerged as the market leader. It was followed by Novartis from Switzerland and Merck & Co. of USA. So, some of the major competitors of Pfizer in the pharmaceutical industry are Novartis, Merck & Co., Bayer (Germany), GlaxoSmithKline (U.K), Johnson and Johnson, Sanofi (France), Abbott Laboratories (USA), AstraZeneca(U.K), Bristol-Myers Squibb, Amgen, Baxter international, Takeda Pharmaceutical Co. (Japan), Genentech, Procter & Gamble, etc. The total revenue generated from the market leaders and big players in the industry crossed USD 479,519 million with the health care and R&D segment crossing USD 70,840 million. The net income generated crossed USD 110,000 million and creating employment of over 1,350,800. Technological Developments In the pharmaceutical industry, the drug patenting and drug licensing is apparently viewed as a gauge for measuring innovation in Research and Development conducted by a company. In this industry, the basis for growth and technological advancement is innovation in R&D that contributes to the economic growth. It is only through the commercialization and use of innovative and fresh products and process, through which the efficiency, scope and quality of goods are measured and expanded in the economy. The drug patenting gives the holder a chance to monopolize the market since only such company would hold patents that are original innovators and invested significantly in the research and development of the drug. Similar drugs as generic brands may be produced by other companies by ensuring that they do not conflict with the patenting rights of the innovator. They may market the original drug in generic version but only after proper rights given by the patent holder and then after clearance of the drug licensing authority (Schacht & Thomas, 2005). Economic Forces Having Major Impact in the Industry Some of the economic factors which have major impact in the industry are inflation rate, economic growth, interest rates, exchange rates, government policies and environmental laws, trade restrictions, etc. along with these factors the technological aspects must not be ignored like the R&D activities, production levels, quality and cost of products. All these factors have direct impact on the company’s performance and operations. For instance, the interest rates impacts the firm’s cost of capital and hence it will determine firm’s production capacity and marketing strategy, cost cutting strategy, R&D investments and other important factors which impacts its growth. Company Analysis To calculate liquidity, efficiency, financial leverage and profitability ratios of Pfizer for 2009 and 2010 and its competitor Abbott Laboratories for 2010 and Evaluating Financial Conditions & Operating results of the Pfizer using Time-Series and Cross Sectional Analysis Cross-Section Ratio Analysis of Abbott Laboratories (ABT) with Pfizer ITEMS 2010 2010 A. Liquidity Ratio ABT Pfizer 1. Current Ratio 1.29 2.13 2. Acid Test Ratio 1.11 1.84       B. Efficiency Ratio     1. Asset Turnover Ratio 0.08 0.34 2. Stock turnover Ratio 4.60 1.91       C. Leverage Ratio     1. Debt Ratio 0.63 0.55 2. Debt Service coverage Ratio 0.37 0.18       D. Profitability Ratio     1. Return on Asset 0.08 0.04 2. Gross Margin 4.43 6.20 Time Series Ratio Analysis of Pfizer ITEMS 2010 2009 % Increase/Decrease A. Liquidity Ratio       1. Current Ratio 2.13 1.66 28.61 2. Acid Test Ratio 1.84 1.32 39.15         B. Efficiency Ratio       1. Asset Turnover Ratio 0.34 0.23 48.62 2. Stock turnover Ratio 1.91 0.68 180.63         C. Leverage Ratio       1. Debt Ratio 0.55 0.58 -4.78 2. Debt Service coverage Ratio 0.18 0.17 11.76         D. Profitability Ratio       1. Return on Asset 0.0423 0.0405 4.42 2. Gross Margin 6.20 4.73 31.25 The company’s financial conditions can be assessed by time series (intra-firm analysis over time) and cross-sectional (inter-firm for a particular time) ratio analysis using the key ratios like liquidity, efficiency, leverage and profitability. Profitability Ratio – The Y-O-Y gross margin of Pfizer increased by 31.25% from 2009 to 2010 indicating strong demand for company’s product and it also increased by 28.55% compared to its competitor Abbott Laboratories in the year 2010. This is a healthy sign for the company because the demand for its products will increase its sales and consequently its margins. Liquidity Ratio – It helps to assess the company’s potential to cover up its short term liabilities with current assets. There is an average increase of liquidity ratios by over 33% Y-O-Y. However, the liquidity of the competitor in the year 2010 is higher due to significant rise in the inventory during the period. Efficiency Ratio – The efficiency of Pfizer has been quiet well over the period under consideration with the turnover ratios increasing by over 114% Y-O-Y. It is much higher than its competitor as well for the year 2010. Higher efficiency means that company’s operating cycle is shorter and it is realizing sales faster. Leverage Ratio – It helps to assess the company’s ability to leverage debt to increase the returns to their shareholders. There has been decrease in debt ratio of the company from 2009 to 2010 indicating the use of more retained earnings and use of less debt. Its competitor however used significant debt to finance its operation and expansions (Nissim & Penman, 2001). Estimating Beta   Pfizer Market Standard Deviation 4.61 7.83 Beta(?) 0.53 1.00 Estimation of the Intrinsic Value of Pfizer Dividend per Share of the Company in 2010 Pfizer Dividends per share in 2010 Date DPS 4-Nov-10 0.18 4-Aug-10 0.18 5-May-10 0.18 3-Feb-10 0.18 Estimating Constant Dividend Growth Rate D1 (Dividend after 1 year) 0.18 P0 (Current Market Price of Pfizer) 14.19 Cost of Capital 6.65% Constant Dividend Growth Rate 5% Determining Expected Return of Stock Using CAPM Market Return 9% Risk-free Return 4% ? 0.53 Cost of Capital (CAPM) 6.65% To Estimate Intrinsic Value of Stock Using Constant Growth Model D1 (Dividend after 1 year) 0.18 P0 (Current Market Price of Pfizer) 14.19 Cost of Capital 6.65% Constant Dividend Growth Rate 5%     Intrinsic Value of Pfizer using Constant Dividend Model 14.19 Conclusion and Recommendation Summary of Economic, Industry and Company Analysis The key economic variables that help to perform fundamental analysis successfully are inflation rate, the GDP of the country, interest rates, consumer spending. Higher inflation rates will mean that the real value of money has declined with time and cost of goods and services will increase. The cost of raw materials, labors, marketing, selling and distribution cost will increase and all companies across all sectors will experience less profit margins. Thus, lower inflation rate will help the economy to grow. The GDP of country is the indicator for its performance in terms of output. The higher the values, the better it is for all the sectors to benefit from the share of GDP pie. Interest rates have direct impact on the cost of capital of the companies. Higher rates would mean that the companies will have to borrow at higher cost and consequently, to cover up cost of operations, they will have to increase the product prices. The consumers will experience higher cost for products and services that will lead to decreased consumer spending. Future Prospect of the Industry and the Company The pharmaceutical industry in United States has many big and multi-national players that make the industry a perfect competition. The Pfizer has performed consistently over many years and was also able to become the market leader. In order to maintain this consistent performance, the company needs to invest more into innovative products and obtain more patents in the future before its competitors. Due to increased competition in this sector, both from the domestic as well as the global markets, the company will always have to look for proper outsourcing countries which will be able to carry out parent company’s operations efficiently at low cost. Such strategy will give the company a competitive edge, gain more market share, enter into new developing market, and diversify their domestic risk. But all these alternatives require the company to make huge capital investments in future and judging its financial statements and performance so far, it looks as an attractive stock for the investor to pick. Comparison of Intrinsic Value of Pfizer with its Market Value The company analysis performed on Pfizer’s stock that is listed on NYSE shows that the company’s intrinsic value calculated using the constant dividend growth model, is 14.19. When this value is compared with the current market price of the stock as on 31 December 2010, it is observed that the value is 17.51. Thus, it can be said that since the current market price of Pfizer is 17.51, which is higher than its intrinsic value, 14.19, there is every possibility that the market price of Pfizer will fall in future since the stock is overvalued. The invested is recommended to sell the stock now and buy later making a profit equal to 3.32 per share (Dong & Hirshleifer, 2005). References Schacht, W. H. and Thomas, J. R. (2005). Patent Law and Its Application to the Pharmaceutical Industry: An Examination of the Drug Price Competition and Patent Term Restoration Act of 1984 ("The Hatch-Waxman Act"). Retrieved from http://www.law.umaryland.edu/marshall/crsreports/crsdocuments/rl3075601102005.pdf. Nissim, D. and Penman, S. H. (2001). Ratio Analysis and Equity Valuation: From Research to Practice. Retrieved from http://www.fargroup.eu/sites/default/files/Ratio%20Analysis%20and%20Equity%20Valuation....pdf. Dong, M. and Hirshleifer, D. (2005). A GENERALIZED EARNINGS-BASED STOCK VALUATION MODEL. Retrieved from http://sites.uci.edu/dhirshle/files/2011/02/A-Generalized-Earnings-Based-Stock-Valuation-Model.pdf. Read More