One of the legitimate challenges any investor faces when market tension is increasing is how far do you go to keep buying stocks when the market looks more and more like it could be reaching the kind of “sea change” turning point that could mark the beginning of a new bear market. There really isn’t a single correct, or best answer to that question; some of the most famous and successful value investors in the market, including Warren Buffett are well-known to keep buying stocks even when the rest of the market is actually going down.
The thing to keep in mind is that most of the stocks these famous value investors are buying are usually going down, too, which is a big part of the reason that when everybody else is selling, you usually see value investors buying. They’re willing to keep buying stocks that they see as bargains under current market conditions – even if those conditions keep a stock’s price going down for the foreseeable future. That’s because they don’t buy a stock with a short-term time frame in mind. Value investors invariably are long-term investors, willing to hold a stock for years as long as their analysis indicates the stock still should be worth more than the price they’ve paid for it.
This is an approach that sounds attractive to most investors, but in reality isn’t that easy to stick to. Bear markets have a way of washing out less disciplined investors, who either buy too much of a single stock, or simply don’t change their strategy. When the market starts dropping, these are the ones that get taken out the most quickly, usually because they bought the wrong stocks at the top of the market and are facing the most immediate losses. Value investors don’t keep buying stocks without regard for current market conditions; in a bear market, they become very selective about what kinds of stocks they’re willing to work with, and they’re careful and deliberate about how much of any single stock they allocate their hard-earned dollars into.
If the value proposition is good enough, value investors also don’t worry too much about whether the industry the stock is in is in or out of favor by the broad market; they know that if it is out of favor, at some point it will come back in favor and that will help drive the stock back up again. That means that they don’t focus on trying to work with “defensive” sectors or industries that tend to be less cyclical in bear markets, unless there are very impressive valuations in those stocks to be had. It also means they won’t shy away from stocks that tend to be much more volatile, even when the market is going up. Since their main focus is on what the stock should be worth, it the bargain opportunity is good enough, that is really the prime driver for the kinds of stocks they’ll pay attention to.
I’m pointing this idea out because the stock I’m writing about today is quite a bit different from a lot of the other stocks I’ve been writing about lately. Gilead Sciences Inc. (GILD) works in the pharmaceutical industry, and while that industry plays a critical role in the economy, as an investment it tends to be highly cyclical and can also be highly volatile. Even in a bullish market, pharmaceutical stocks like GILD don’t work very well for the faint of heart, simply because they can experience wide swings from high to low. The other truth, however is that GILD is a leading company in its industry, with a very impressive set of fundamentals, a broad product portfolio, and an impressive value proposition that should put the stock at on any sensible value investor’s radar.
Fundamental and Value Profile
Gilead Sciences, Inc. is a research-based biopharmaceutical company that discovers, develops and commercializes medicines in areas of unmet medical need. The Company’s portfolio of products and pipeline of investigational drugs includes treatments for Human Immunodeficiency Virus/Acquired Immune Deficiency Syndrome (HIV/AIDS), liver diseases, cancer, inflammatory and respiratory diseases and cardiovascular conditions. Its products for HIV/AIDS patients include Descovy, Odefsey, Genvoya, Stribild, Complera/Eviplera, Truvada, Emtriva, Tybost and Vitekta. Its products for patients with liver diseases include Vemlidy, Epclusa, Harvoni, Sovaldi, Viread and Hepsera. It offers Zydelig to patients with hematology/oncology diseases. Its products for patients with various cardiovascular diseases include Letairis, Ranexa and Lexiscan. Its products for various inflammation/respiratory diseases include Cayston and Tamiflu. GILD’s current market cap is $93.8 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings declined a little over 30%, while sales dropped almost 21%. In the last quarter, earnings increased almost 28% while sale posted an increase of 11%. The company also operates with a strong margin profile, since Net Income versus Revenues was 9.51% over the last twelve months, and even more impressively increased to 32% in the last quarter.
- Free Cash Flow: GILD’s free cash flow is healthy at about $8.4 billion for the last twelve months. This is a number that has declined in almost every quarter since the beginning of 2016, when it peaked at nearly $20 billion. That still does translate to a Free Cash Flow Yield of about 8.87%, which remains pretty attractive.
- Debt to Equity: GILD has a debt/equity ratio of 1.23. This number is higher than I generally prefer to see, but isn’t unusual for pharmaceutical stocks. The company’s balance sheet shows that operating profits are more than adequate to service their debt; in addition, GILD has excellent liquidity with cash and liquid assets in the last quarter of $25.6 billion against long-term debt of $26.7 billion.
- Dividend: GILD pays an annual dividend of $2.28 per share, which translates to a yield of 3.15% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for GILD is $16.77 per share and translates to a Price/Book ratio of 4.31 at the stock’s current price. The stock’s historical Price/Book ratio, however is more than 10, which offers what is probably an over-optimistic long-term target at nearly $170 – almost $50 above the stock’s all-time high price, which was reached in mid-2015 at around $124 per share. The stock’s Price/Cash Flow ratio is also more than 50% below its historical average, however, so put together it doesn’t seem unreasonable to suggest that if you are willing to work with a very long-term time horizon, the stock has good reason to test that historical high.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The chart above outlines the stock’s movement over the past year. The stock peaked at nearly $90 in late January with the rest of the market, but has dropped back more than 19% from that point. Since May, the stock has increased about 12%, but since July has been holding in a relatively narrow range between $77 on the high side and support at around $72. The stock is very close right now to support around $72; this could mark an important turning point for the stock, since another pivot low with a move higher should give the stock room to run to around $78 or $79 in the near term, but a drop below support could see the stock retest it trend low around $64.
- Near-term Keys: If you want to work with a short-term time frame, you should really be looking to see what the stock does around $72. If it does pivot and rally back to the upside, you could have a nice short-term opportunity to buy the stock or work with call options, while a break below support might be a good reason to short the stock or work with put options. If you’re willing to accept some volatility, on the other hand, the stock’s current price really does offer an interesting bargain proposition; that is true even if you factor in the stock’s 12% rise since May. A new surge in bullish momentum could start to drive the stock to extend the upward trend in began at that point even further.