Looking at Low Valuations

I want to show you the dramatic collapse in stock valuations by taking a close look at Pfizer (PFE), the drug company. I’m not recommending the shares to own, I simply want to show you how extreme the market’s judgments have become.
Yesterday, shares of Pfizer closed at $17.29. Looking deeper, we see that the company has a very large cash horde of $26 billion, while a fairly modest long-term debt position of $7 billion. In this environment, it certainly pays to be cash-rich. Pfizer’s cash position works out to about $3.86 a share. That means you can pick up the company’s operations—the nuts and bolts of the business—for just $13.43 a share.
Now, here’s a look at Pfizer’s stock along with its earnings-per-share. The black line is the stock and it follows the left scale. The gold line is the EPS and it follows the right scale.

The graph is scaled at a ratio of 10-to-1, so when the lines cross, the P/E ratio is exactly 10. Not a pretty sight, but the earnings are moving in the right direction. As you can see, Pfizer’s P/E ratio has plunged far below 10, and that’s including the company’s generous cash balance.
We can see that Pfizer’s earnings are climbing although the growth rate isn’t terribly strong. For 2009, Wall Street sees earnings coming in at $2.49 a share. Just by eyeballing the recent trend, that seems reasonable. So working with the $13.43 figure we can see that Pfizer is really going for about five times next year’s earnings, or an earnings yield of about 18.5%, which is several times what you can find in the bond market.
Now let me point out a few caveats. Price/earnings ratio is hardly a perfect measure of value. Also, Pfizer is a company that faces many challenges so many of these numbers are simply guesses about the future. The important point is that the recession has left us with stocks that have much cheaper real valuations than a few months ago, even companies that aren’t so dependent on the credit markets. After all, Pfizer is still a cash-flow-positive company and that isn’t about to change anytime soon.
Pfizer currently pays a 32-cent quarterly dividend. The company made some news recently by declining to raise its dividend for the first time in four decades. Going by yesterday’s close, that’s a dividend yield of 7.4%.
If a five-year Treasury currently gets you just 1.5%, then the market is terrified of stocks like Pfizer.

Posted by Eddy Elfenbein on December 30th, 2008 at 11:27 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.