One of the most impressive gains reported so far this quarter are those of Gilead Sciences (GiLD) . Quarterly earnings per share were up 50% to 78 cts , or $673 million, and quarterly sales were up 31% to $1.8 billion. Their HIV drug Truvada and Atripla had sales gains of 13% and 43% respectively. Their Tamiflu royalties rose sharply, about 5 fold, given the strong demand from the swine flu vaccine. At a run rate of 78 cts per quarter or $3.12 per year, their P/E is 14.25 ( 44.49 / 3.12). For a growth company with a sustainable business their P/E should be closer to 20 times earnings and their price closer to $62 per share vs $45 now. Given that huge discount, and margin of safety, this company is an outright buy.
Gilead’s 5 year return on capital exceeds 21%, its long term debt to equity ratio is .21, its cash on hand exceeds its long term debt, and its free cash flow exceeds it accounting earnings. Today the stock is down probably because of the inside game played by Wall Street analyst and hedge funds in front running the numbers with insiders information and then distorting the results. Gilead’s numbers easily beat expectations for both sales and earnings. The sustainability of demand for HIV products is for now assured, as there is no remedy that effectively eliminates the HIV virus.
Too big to fail when it concerns banks will eventually lead to much higher capital requirements, or to the outright separation of commercial banking and trading operations. The systemic risk to the entire economy is just too large to allow that to happen again.
That implies an element of operational uncertainty for banks like Citibank and Bank of America as their business models and capital requirements will be forced to change. It will be amusing to see how that sorts itself out in the years to come. If you then include the fantasy accounting banks apply to financial statements, which adds another layer of complexity in evaluating their businesses, the end result is a lot of blur, making it very difficult for investors to even know what the definition of is is (Clinton circa 1998).
This uncertainty about their business models complicates any fundamental analysis to the point of rendering it useless, and that leads me to believe that one should trade these firms purely on a technical basis, that is chase momentum until it stops. To extrapolate their current earnings into the future, is beyond naïve, and probably outright silly.
Retail sales for the month of Sept. were down 1.5%. We are still not out of the recessionary funk, though some companies are reporting improved earnings. Intel’s revenues were down 8% from the prior year though they beat earning’s estimates, and on the banking side JP Morgan beat earning’s estimates significantly along with a small improvement in revenues.
Intel is basically a monopoly, with at least a 75% share of the market, and for that reason I would pay up to 15 times earnings and still feel I have a margin of safety, given its durability, proprietary architecture, and market dominance. Nobody has the intellectual know how and manufacturing capability and market dominance to challenge them today. When a new manufacturing plant costs in excess of $4 billion, you have to wonder if anybody would dare risk that investment to compete . They do however lag in mobile computing and are focusing to get up to speed in that emerging market.
With current earnings at 33 cts per share in this recessionary quarter and with gross margins raising significantly above 55%, they should be able to achieve earnings of $ 1.5 per share next year. At that earnings run rate the stock is easily worth $22.5 versus the present price of $21.07. It current dividend yield is about 2.6%. Certainly this company is Investment worthy given its high return on capital (16%) and forward P/E ratio of about 14. At the peak of the economic cycle, this company is likely to earn more than $2 per share and trade at least at $30 per share, which i figure may happen sometime in 2011. That risk/ return ratio is attractive enough to warrant initiating an investment position.
Generally speaking, unless you have a special insiders insight into a business, buying at a P/E of 12 or lower gives you a good margin of safety, assuming the enterprise is sustainable. Furthermore, if the business has an average return on capital that is above 12% over several years, a low debt to equity ratio , and free cash flow that matches reported earnings than you generally have a viable investment. However, if you have superior predictive powers, you can toss the above out the window and do whatever you like, and especially so if you are young , good looking and rich.
If you are better informed to predict, or have superior analytical skills, that may give you an edge in predicting and allow you to relax the above constraints. From observation, it usually pays to be dogmatic and follow the guidelines I proposed before investing. Generally you should accept the idea that you cannot predict reliably enough to risk capital.
We are now at the beginning of the earnings reporting season. The few companies that have reported so far are again exceeding earnings estimates, but hardly any have sales growth. Sales growth is paramount. Let us await for more earning releases to see which stocks appear mispriced relative to present and future performance before investing further.
