Roche (XSWX:RO, Financial)'s story is different, and even more provocative. Its revenue growth has been quite steady, shifting only slightly from 9% in the 1991 to 2005 period down to 8% in the 2005 to 2012 period. Its earnings and P/E multiple, however, have been more jumpy throughout the multi-decade period, largely because Roche has had negative earnings years such as 1997 and 2002. Still, there is a very clear drop in sentiment in the recent period not reflected in fundamental results. That is, in 2005 Roche earned $1.37 per share, rising to $3.02 per share last year—a growth rate of +11.9% annually— without any negative earnings years. The recent steady growth is far better, we think, than the volatile rise of 3 +9.8% per year from 1991 to 2005. And yet the market chopped Roche's P/E ratio in half, from 27.3x in 2005 to 13.6x in 2011 (before it recovered a bit recently).
What we see, then, is two companies with very long, strong track records before one even considers any details about the businesses—and both stocks are much cheaper than they have been historically. That prompted us to investigate, and when we dove deeply we got even more interested...
In our view, Roche has traditionally been misunderstood. It has generally been priced as a traditional pharmaceutical company, but in reality it functions as a biotechnology giant. That is, after fully acquiring long-time partner Genentech, 70% of its revenues come from biologics, which have much higher margins than traditional compounds. This structure allows the company to fund the world's largest pharmaceutical R&D budget of $9 billion annually. It homes in on targeted therapy cancer drugs in particular. While most competitors are still at the nascent stage of evaluation, Roche already has some of these personalized treatments on the market and many in late-stage development. Roche is at the forefront of immunotherapy—drugs eliciting the body's natural immune system. Such drugs potentially offer a breakthrough, curing certain types of cancer, meaning patients now measure success in somewhat lengthened lifespans. With many drugs already on the market and this type of very promising pipeline, we have a hard time seeing the company as a slow grower.
From John Rogers (Trades, Portfolio)' Ariel International Fund & Ariel Global Fund fourth quarter 2013 commentary by Rupal J. Bhansali.
