News Analysis date published New: 
Wednesday, March 2, 2011 - 07:00
New Date created: 
Wednesday, March 2, 2011 - 07:00
New Date last updated: 
Wednesday, March 2, 2011 - 07:00

The 3 Best Pharma Stocks to Buy Now

Wednesday, March 2, 2011 - 7:00am

The market has been on fire since the dark days of the financial crisis. The S&P 500 has soared an astounding 85% since the lows of March 2009. Market returns have been propelled by more cyclical sectors like technology and consumer products, while the more defensive sectors have badly lagged the market. In short, it's the go-go stocks that have been the first to benefit in the post crisis market, but things might be changing...

The bull market has gotten long in the tooth while at the same time uncertainty is growing as the Middle East erupts in turmoil. Oil prices are soaring near $100 a barrel from just $85 a month ago and may climb still higher, threatening economic recovery.

It may be time for investors to look at defensive stocks that can perform in any economy. Health care, more specifically major drug manufacturers, earn consistent income in any economy and, best of all, pay fat dividends.

Health care stocks have their critics, however. Most large drug companies are facing steep patent cliffs and an accompanying fall in revenue in the years ahead. In addition, uncertainty regarding health care legislation and possible higher costs going forward are weighing on prospects. However, these problems are largely factored into share prices already.

Three stocks in particular stand out as having strong business prospects, cheap valuations and high dividends.

1. Bristol Myers Squibb (NYSE: BMY) markets drugs worldwide and is one of the largest pharmaceutical companies in the world. The company sells at a higher price-to-earnings (P/E) ratio (14) than most Big Pharma companies (the industry average is 13), but still lower than the overall market (15.4). Bristol also pays a solid 5.2% dividend yield, compared with 2.1% for the overall market and 4.5% for the pharmaceutical industry.

Like most major drug companies, Bristol faces costly patent expirations. Blockbuster drugs Plavix (cholesterol) and Abilify (anti psychotic drug), which account for nearly half of net sales, will lose patents in 2011 and 2012. Also, most of Bristol's sales are generated in the United States, meaning the company will be negatively affected by the new health-care reform bill, which requires discounts on drugs for patients using Medicaid. However, these problems are already reflected in the stock price and the company has solid prospects going forward.

Bristol Meyers has sold off most of its noncore businesses and is focusing exclusively on drugs. The company has cut $2.5 billion in operation expenses in the past few years as well, and has more than $5 billion in cash that it can use for acquisitions. It also has a robust pipeline of cancer drugs with a strong track record of FDA approval. The stock has an excellent chance to impress going forward, and the dividend is well supported with a 61% payout ratio.

2. Eli Lilly and Co. (NYSE: LLY) has been around since 1876. The company makes top drugs in a variety of areas, including antidepressant drug Prozac and neurological drug Zyprexa. Lilly is truly a global powerhouse, with product sales in 143 countries.

Lilly faces steep patent expirations in the next two years on drugs accounting for about 40% of sales. But this problem seems well reflected in the stock, which sells for about seven times earnings, well below the market (15.4) and industry (13) averages.

Like Bristol, Lilly is ambitiously trying to fill the looming patent hole. The company acquired biotech giant Imclone in 2008 and has been investing heavily in its internal pipeline of new drugs. Lilly has also built a war chest of $6 billion and is in a good position to make more acquisitions to boost earnings. In the meantime, the drug giant pays a 5.7% dividend yield that's strongly supported by a 41% payout ratio.

3. Abbott Laboratories (NYSE: ABT) is more diverse than Lilly and Bristol, with pharmaceuticals generating less than 60% of revenue. The company has four main product segments, including pharmaceuticals, medical devices, diagnostics and nutritional products. In addition to prescription drugs, notable products include coronary and carotid stents, as well as baby formula.

The interesting thing about Abbott is that it doesn't have nearly the patent expiration cliff that other large pharmaceutical companies have, yet the stock price has been held down along with all the others anyway. And Abbott has grown earnings by an average of 13% in the past five years.

Abbott has a strong mix of pipeline and existing drugs, including cardiovascular drug Trilipix, which has blockbuster potential. Selling at just over 11 times earnings with a dividend yield of 3.6%, Abbott fits the mold of a defensive and cheaply valued dividend play.

Action to Take --> This is an excellent environment for defensive, cheaply valued companies that pay strong dividends. Longer term, the dynamics for health care companies are quite promising as the U.S. population continues to age and emerging market populations get richer and seek medical treatment. All three of these companies can be purchased at current prices.

Tom Hutchinson does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.