Why are investors willing to pay only 10 times earnings for some stocks, but 20, 50, even 100 times earnings for others?
The short answer: growth. Companies that can grow their earnings meaningfully could make lofty current P/E ratios look cheap in hindsight.
Of course, any company can promise a rosy, growth-rich future. Figuring out which companies can actually deliver is far trickier. In this series, I take the first step by identifying companies that have put up the best growth track records in their respective sectors.
Below, I've listed the top 10 sales growers in pharmaceuticals over the last five years. Here's how to interpret each data column.
Five-year sales growth: I rank each company's sales growth, to capture its pure trailing expansion without regard to the vagaries of earnings.
Five-year EPS growth: Since sales growth means nothing if it doesn't ultimately fall to the bottom line, I've also included each company's five-year trailing EPS growth rate.
Five-year analyst estimates: This column shows us how much EPS growth analysts expect over the next five years. Just keep in mind that analysts tend to grossly overestimate a company's prospects.
Five-year ROIC range:Return on invested capital basically shows you how efficiently a company is converting its debt and equity into profits. We want companies that can do a lot with a little. By looking at the five-year range, we can start to gauge both the power and the consistency of a company's profit engine.
5-Year Sales Growth
5-Year EPS Growth
5-Year Analyst Estimates
5-Year ROIC Range
Optimer Pharmaceuticals (NAS: OPTR)
-115% / -16.4%
DepoMed (NAS: DEPO)
-48.1% / 1949.2%
Questcor Pharmaceuticals (NAS: QCOR)
-5.3% / 104.3%
Xenoport (NAS: XNPT)
-47.6% / 0.1%
-53.3% / -24.3%
3.6% / 14.3%
Hi Tech Pharmacal
-7.1% / 24.7%
ViroPharma (NAS: VPHM)
5% / 14.5%
9.9% / 18.5%
-10% / 10.7%
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful; EPS growth that is NM results from losses during the period. N/A = not applicable; analyst estimates that are N/A result from lack of analyst coverage.
Use the table above as a first step to help you generate ideas for your own further research. Once you identify stocks worth a closer look, the following three steps will help you further assess their growth prospects:
Carefully study the table for possible danger signs, such as high sales growth but low EPS growth, analyst growth expectations significantly trailing past growth, and low ROIC figures. Then follow the trail.
Find out how the company achieved its prior growth: organically, or via acquisition? Can it sustain that previous growth?
Pay attention to how management plans to implement its growth plans. Does its strategy seem prudent and plausible to you?
The pharmaceutical industry is especially tough to make decisions on relying on raw numbers. None of these 10 top growers look great on the initial numbers. They all have high sales growth, but they fall apart somewhere along the profitability chain. Here we have to factor in the chase for FDA approval and then once they're approved, the potential for huge sales.
For example, the top grower, Optimer, has grown so much due to the approval of its C. difficile infection treatment Dificid in 2011, which has jumpstarted its sales from virtually zero.
So this list of top growers isn't an ideal way to find the next potential FDA approval. But it may help you spot an up-and-comer. The opportunity here is if you believe the market is mispricing a company's potential.
Learn more about any of the stocks that interest you by adding them to our My Watchlist tool. You'll get access to all the latest Motley Fool analysis, organized by company.
At the time thisarticle was published Anand Chokkaveluowns shares of Optimer.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.