Is Pfizer a Buy?

Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The biggest pharmaceutical companies in the United States are in an enviable position. They sell products that are literally a matter of life and death. People who take medication will pay for it no matter what, and will often cut back on many other necessary expenses if need be.

As a result it should be no surprise that some of the market’s best performers last year came from the large-cap pharma space.

Pharmaceutical giants Bristol-Myers Squibb (NYSE: BMY) and Eli Lilly (NYSE: LLY) are both up more than 30% over the tailing 52 weeks. Industry heavy-weight Pfizer (NYSE: PFE), one of the biggest companies in the world and a Dow 30 component, has also climbed 30% over the past year. Consider, also, that these fantastic returns don’t even include the generous dividend yields that large-cap health care stocks are known for.

Should investors continue to pile into Pfizer at these levels? Or, on the other hand, are you better off sitting on the sidelines?

Rising valuations and falling sales are causes for concern

The spiking share prices among these stocks are confusing given the struggling underlying performance of many of these firms. For example, Bristol-Myers Squibb reported full-year 2012 net sales that were 17% lower than the previous year. Likewise, Eli Lilly reported that full-year 2012 revenues declined 7% year over year.

For Pfizer’s part, the company’s 2012 sales declined 10% year over year, which management blamed mostly on the patent loss of its blockbuster cholesterol drug Lipitor.

Pfizer is experiencing both struggling sales and rising expenses as it scrambles to replace its best-selling drug ever. This is a dangerous combination, especially in light of the lofty valuation it now enjoys due to its impressive share price performance over the past year.

To illustrate, Pfizer’s first-quarter sales fell again, this time by 9% year over year. On top of that, the company cut its outlook for full-year 2013. The company now expects diluted earnings per share to come in between $1.44 and $1.59, down from its previous expectations of $1.50 to $1.65 per share. At current prices, Pfizer trades for 19 times the midpoint of its revised outlook.

Wait for a pullback

Many stocks within the pharmaceutical industry have rallied significantly over the past few years and now sit at multi-year highs. It’s not hard to understand why: in today’s investing environment of historically low interest rates, bank products like certificates of deposit pay little to no interest. The 10-Year U.S. Treasury Bond still yields just 2.2%, so high-quality equities like these stocks that provide yields in excess of 3% must seem extremely attractive to income investors hungry for yield.

It's understandable that investors are lured into buying Bristol-Myers, Eli Lilly, and Pfizer.  At the same time, it's important to remember that those dividend yields will rise if share prices fall. Investors who are willing to exercise patience might be able to secure yields closer to 4% should the disappointing underlying results finally catch up to these stocks' share prices.

Furthermore, investors who blindly chase high-performing stocks just for the sake of yield may be making a mistake. Unfortunately, large-cap big pharma stocks aren’t offering growth rates to justify their huge rallies, and as a result, investors would be wise to view the industry with caution.

Specifically, Pfizer has rallied significantly despite offering little underlying growth. Going forward, the picture remains extremely cloudy as a result of the company losing Lipitor patent protection. I’m not willing to pay 19 times 2013 earnings for a company losing exclusivity on its best-selling product, and I’d advise investors to follow suit and wait for a meaningful pullback before jumping in.

Is Eli Lilly a buy or sell?
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Robert Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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