Boosting Big Pharma Valuations on Lower Cost of Equity Assumptions

Morningstar analysts are moderately increasing valuations across the pharmaceutical sector

Damien Conover, CFA 3 June, 2013 | 6:01PM
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After reassessing the long-term historical return characteristics of Big Pharma stocks and their relationship with the overall market, we are lowering our cost of equity assumptions to better reflect the defensive nature of drug companies relative to the overall market.

We believe low systematic risk accurately reflects the relationship between the pharmaceuticals industry and the overall economy as pharmaceuticals spending tends to only moderately correlate with macro-trends given its essential nature, and the earnings volatility for the industry mainly stems from individual company characteristics rather than swings in economic growth.

Financial leverage, another lever in our systematic risk calculations, also tends to be at the low end of the spectrum for the industry, supporting our new systematic risk thesis. With the exception of Bayer (BAYN) (which carries a higher degree of systematic risk, in our pinion), we believe that a corresponding 8% cost of equity is a more appropriate benchmark for long-run returns for the industry.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
AstraZeneca PLC8,996.00 GBX1.50Rating
Bayer AG48.32 EUR0.27Rating
GlaxoSmithKline PLC1,420.80 GBX0.71Rating
Johnson & Johnson163.72 USD0.20Rating
Novartis AG77.54 CHF-0.01Rating
Sanofi SA85.11 EUR1.38Rating

About Author

Damien Conover, CFA  is an equity analyst and associate director at Morningstar.