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Gilead Sciences Inc: Strong Growth at an Unreasonably Low Price

May 21, 2012 | About:
Gilead Sciences Inc. (GILD) is an innovative healthcare company with a strong record of historical earnings growth and expectations for above-average growth into the future. Nevertheless, Mr. Market seems unwilling to recognize the past and future earnings power of this niche pharmaceutical growth stock. Consequently, the company trades at a single-digit P/E ratio that we believe significantly undervalues both the company’s past and future potential. Therefore, investors seeking high growth at a reasonable level of risk might want to look further into this undervalued growth opportunity.

Growth stocks are defined as companies with high rates of change of earnings growth of 15% to 20% or better. Growth stocks offer the potential for share prices to rise in lockstep with their profit growth in the long run. Therefore, the PEG ratio formula (price equals growth rate) tends to be the most appropriate formula used to value growth stocks. However, due to the exponential nature of compounding large numbers, PEG ratio forecasts are capped at 40%.

Because of the higher valuation typically awarded to fast growth, growth stocks offer the potential for greater capital appreciation. On the other hand, they also offer higher risk. First of all, they tend to command much higher than average P/E ratios, and second, achieving very high levels of growth is very difficult to sustain. Consequently, forecasting future earnings growth is more important with high growth stocks than any other class of stock. Also, the average growth stock typically ploughs all of its profits back into the company to fund its future growth, instead of paying dividends.

Gilead Sciences Inc: Large-cap Growth at an Attractive Price

About Gilead Sciences Inc: Directly from their website

“Gilead Sciences is a biopharmaceutical company that discovers, develops and commercializes innovative therapeutics in areas of unmet medical need. The company’s mission is to advance the care of patients suffering from life-threatening diseases worldwide. Headquartered in Foster City, California, Gilead has operations in North America, Europe and Asia Pacific.”

Earnings Determine Market Price: The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings. Here is a link to a live and fully functioning graph on Gilead Sciences Inc. We suggest running graphs over numerous time frames as part of a more comprehensive fundamental analysis.

Gilead Sciences Inc: Historical Earnings, Price, Dividends and Normal PE Since 2004.

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Performance Table Gilead Sciences Inc.

The Two Keys to Long-Term Performance

Years of research and experience have taught us that there are two critically important keys to achieving above-average, long-term shareholder returns at reasonably controlled levels of risk. The first key is earnings growth, or what we like to call the rate of change of earnings growth. The faster a company can grow its business (i.e. earnings), the larger the income stream it can produce with which to reward shareholders. This is because of the power of compounding, which Albert Einstein was alleged to have called "the most powerful force on earth." Ultimately, both capital appreciation and dividend income will be a function of a company's ability to grow its profits.

The second key is valuation. When a company can be purchased at its intrinsic value based on earnings and cash flow generation, the shareholders' rate of return or long-term capital appreciation will inevitably correlate to and/or equal its earnings growth rate. Overvaluation will lower that rate of return and conversely, undervaluation will increase it. Consequently, paying strict attention to the valuation you pay to buy a stock is a critical component of both greater return and taking lower risk to achieve it. Because, ironically, when you overpay for even the best business, you simultaneously lower your return potential while increasing your risk of achieving the lower return.

The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two keys to long-term performance. Notice the impact that valuation (black line above or below orange earnings justified valuation line) had on the following performance results.

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The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 2004.

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A further indication of valuation can be seen by examining a company’s current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for Gilead Sciences Inc is 4.33 which is historically low.

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Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:

1. The rate of change (growth rate) of the company’s earnings

2. The price or valuation you pay to buy those earnings

Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.

Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. Gilead Sciences Inc is clearly an industry leading superior business, which based on the consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, Gilead Sciences Inc represents an opportunity for growth at a reasonable price. The important factor is that Gilead Sciences Inc, with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized future returns.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

The consensus of 28 leading analysts reporting to Capital IQ forecast Gilead Sciences Inc.’s long-term earnings growth at 17%. Gilead Sciences Inc has medium long-term debt at 53% of capital. Gilead Sciences Inc is currently trading at a P/E of 13.4, which is below the value corridor (defined by the five orange lines) of a maximum P/E of 20.4. If the earnings materialize as forecast, Gilead Sciences Inc.’s True Worth™ valuation would be $139.05 at the end of 2017, which would be a 20% annual rate of return from the current price.

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Earnings Yield Estimates

Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stake holders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in Gilead Sciences Inc to an equal investment in 10 year Treasury bonds, illustrates that Gilead Sciences Inc.’s expected earnings would be 9.7 times that of the 10 Year T-Bond Interest. (See EYE chart below.) This is the essence of the importance of proper valuation as a critical investing component.

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Summary & Conclusions

This report presented essential “fundamentals at a glance” illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it’s imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.

At its current quotation, Gilead Sciences Inc. appears to offer significant upside based on several factors. First of all, the company is trading at a below average PE ratio even though it offers above-average growth. Therefore, the aggressive investor could be rewarded with significant PE expansion in addition to above-average growth. Furthermore, since the stock is trading art a single digit PE ratio, we believe there is little downside assuming the company’s fundamentals do not significant deteriorate. Therefore, this may be an ideal research candidate for the aggressive investor seeking maximum capital appreciation at controlled levels of risk.

Disclosure: No position at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. A comprehensive due diligence effort is recommended.

About the author:

FAST Graphs
F.A.S.T. Graphs™ is a powerful research tool providing "essential fundamentals at a glance" on over 17,000 symbols. F.A.S.T. Graphs™ empowers the user to research stocks deeper and faster by allowing them to exploit the undeniable relationship and functional correlation between long-term earnings growth and market price. Warren Buffett, the greatest capital allocator of all time, said; "there are only two things that investor needs to know; how to value a company and how to think about stock prices." With the F.A.S.T. Graphs™ at their disposal, users are able to perform both of these critical tasks... FAST.

F.A.S.T. is an acronym for Fundamentals Analyzer Software Tool that takes all the hours of manual graphing of business fundamentals and reduces it to seconds, giving you critical information in an instant. With one glance you know a lot about the business you are graphing and its past, present and future value. F.A.S.T. Graphs™ should be the first step in every research project. Each graph is worth 1,000 words in describing a company's growth, consistency and valuation.

Visit FAST Graphs's Website


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