Pfizer Price Check

Thursday, December 14th, 2006 | FPF Value, Model Portfolios, Stock Research with 20 Comments

Pfizer logoEarlier this week, I detailed why I think Pfizer (PFE) has a wide moat.  Today, I’m going to discuss what I believe Pfizer’s stock is actual worth.  Determining a stock’s intrinsic value is critical in determining whether there is a significant margin of safety in investing in that stock.

The intrinsic value of a stock is simply the present value of future owner’s earnings.  I use free cash flow often to estimate the earnings available to owners.  Free cash flow is just net cash from operating activities (found on the statement of cash flows) minus capital expenditures.  Ideally, I like to look at the past 10 years worth of free cash flows.  The past 10 years of free cash flows for Pfizer are indicated by the green dots plotted on the graph to the left.  Over the past trailing twelve months, free cash flows were $15,647 million.

Pfizer free cash flow graphI took the past 10 years worth of annual free cash flows for PFE and the trailing twelve months of free cast flows (FCF) and I drew a line through them.  Actually, I did this by running a linear regression of the free cash flows over time.  The trend is characterized by the equation: FCF(i) = 1604.9(year) + $14,926.  This means that free cash flows start at $14.9 billion and grow by $1.6 billion each year. 

Many would argue that a percent growth rate would be more appropriate to model FCF growth, but I find that linear trends are more conservative and often fit the data better for wide moat companies with consistent earnings.  However, if you are still interested in the growth rate for my forecast, it is about 9%.  You might notice the R2 = 0.93 in the graph above.  That number indicates that 93 percent of the variation in free cash flows over the past 10 years can be explained by the linear trend line.  That is a good sign that the linear trend is good at describing past free cash flow growth.  However, this analysis still suffers from looking in the rear view mirror while trying to see what is coming ahead.  This is definitely not a safe way to drive, and in investing this is one of the reasons why I insist on maintaining a wide margin of safety.

I am currently using a 10 percent discount rate and a perpetual growth rate of 3 percent for growth after 10 years.  The 3 percent steady state growth rate is loosely based on GDP growth rates.  My discount rate minimum is 10 percent. Since the 10 year Treasury Note rates are so low (4.58%), I am currently falling back on my default of 10 percent.  This is similar to the way I believe Warren Buffett does this.

Using these inputs, I calculated an enterprise value of $283.5 billion.  To get the intrinsic value of equity, I then added back $1.177 billion in cash and subtracted $5.561 billion in long term debt.  That gave me an equity value of $279.158 billion, which then divided by 7.251 billion shares gives a per share intrinsic value of $38.50.  With PFE trading at around $25, the margin of safety is greater than 50%.

In addition to running this 10 year growth model, I also looked at a 5 year growth period as well.  The five year growth model looks back five years to estimate the linear trend in FCF growth and then it projects out five years of future free cash flows.  This model had a lower R-squared of 89%.  The resulting intrinsic value estimate was somewhat lower at $36.66 per share, but that price still provides a significant margin of safety.

I also decided at this point to take a peek at what analysts where forecasting growth would be over the next five years.  According to the numbers at Yahoo! Finance, the average forecast in growth in earnings over the next five years is 5%.  It’s interesting to note that at the end of 2004, analysts were predicting 11% growth per year over the next five years.  I believe the 5% growth rate is an overreaction by analysts to the recent bad news to hit Pfizer.  Nevertheless, I used this 5% growth rate for earnings and the average projected earnings per share of 2.18 to determine the intrinsic value of Pfizer shares using Graham’s Formula.  This quick and dirty formula gives me an intrinsic value of $33.80 ($2.18*(8.5+2*5)*4.4/5.25).  Even this lower intrinsic value still provides an acceptable 26% margin of safety.

A few things to look out for when calculating intrinsic values include: share dilution, stock option expenses, and pension liabilities.  Share dilution seems under control with the number of share outstand dropping to 7.2 billion recently from a high of 7.5 billion two years ago. Stock options had an estimated cost of $457 million out of $8 billion in net income, which is 5.7% of earnings.  This is higher than I would have liked, but not unexpected for this type of company.  Finally, there are significant pension liabilities and other post retirement benefit liabilities on the balance sheet.  At the end of 2005, it looks like projected U.S. pension benefit obligations exceeded the fair value of plan assets by about $1.1 billion and international pension benefit obligations exceeded the fair value of plan assets by $2.4 billion.  The future expenses of stock options and pension liabilities could likely reduce owner’s earnings, but I haven’t made any adjustments at this time since the significant margin of safety I believe could cover these costs.

I’ve looked at the intrinsic value of Pfizer using a few methods detailed above.  My conclusion is that the intrinsic value per share of Pfizer falls between $34 and $38.50.  This estimate indicates that there is a significant margin of safety.  This will be particularly important if Pfizer is not able to maintain a steady stream of new patent protected drugs or in the unlikely scenario that Congress passes legislation curtailing drug costs (this concern is over-hyped right now).  If all goes well, I will collect a 3.8% dividend while I wait for Pfizer’s stock price to rise back up to its intrinsic value. I wouldn’t be surprised to find Pfizer overvalued in a few years if manic Mr. Market changes his negative attitude on drug stocks, and Pfizer in particular, and decides that drug stocks are once again the darlings of Wall Street.

Given the comments I’ve already received on my Pfizer moat check, I expect you will have lots of thought to share on my analysis in the comments section below. I look forward to the discussion.

Disclosure: I now own shares of Pfizer Inc. since December 7, 2006.


Comments

  • George,

    As usual – nice work. I really appreciate seeing the legwork in ones analysis. Some people deem their methods “proprietary” and seem not eager to share.

    I think the unfortunate thing, is that PFE (as with most all companies that rely on intangibles on the balance sheet), is that they get passed up when running a simple NCAV calculation (current assets – total liabilities). In the case with PFE, their total assets for the MRQ is $108.5 bil. However, of that, only $38.7 bil is in liquid assets. With total liability of $38.8, their NCAV is actually in the red.

    Jason December 14th, 2006 at 12:30 pm
  • Thanks Jason for adding the NCAV for MRK here in the comments section. I never even bothered to do that for this case. I only tend to only look at net assets when dealing with distressed companies.

    George December 14th, 2006 at 4:37 pm
  • I am curious… Are you following the ‘Rule Number 1′ method of investing? Your explanation sounds very similar to Phil Town’s method of investing which, actually, is just a bite off of Warren Buffet as far as i know.

    Very good post and being that this is my first time on your site i will enjoy looking around the rest of it.

    Thanks.

    Zig Zo December 14th, 2006 at 6:15 pm
  • Hi Zig Zo,

    I am following Warren Buffett’s style of investing. While I find components of Phil Town’s Rule #1 style of investing useful, I don’t agree with his method of valuing stocks. I’m also sceptical of the usefulness of his “Tools” for technical analysis.

    I hope you enjoy your visit here at Fat Pitch Financials. Be sure to click on the Value Investing News tab before you leave. I think you will like that material as well.

    George December 14th, 2006 at 11:15 pm
  • Excellent work. I got around the same intrinsic value from my calculations as well. I also liked when you pointed out the caveats to DCF such as share dilution, stock option expenses, and pension liabilities.

    I am currently working on my own blog, and was wondering about how you added the buttons to your posts (Add to del.icio.us • Digg This! • Submit To Netscape • Furl This). Is there a guide that teaches this?

    Thanks.

    Tweakie
    Long-time reader

    Tweakie December 15th, 2006 at 12:33 am
  • Hi Tweakie,

    I’m glad you like my analysis. As to your question, I’m using FeedBurner’s FeedFlare service to add the social bookmarking buttons to my posts. FeedBurner provides many great services you’ll find very helpful as a new blogger and the price is right. It’s free!

    George December 15th, 2006 at 12:46 pm
  • George,

    Nice article. This is actually the first time I came across your site. I also saw the current price $25 ish is a good buy, thanks for your analysis on actually showing why it is.

    Thanks!

    Andy December 15th, 2006 at 2:21 pm
  • Nice article George,
    your analysis was thorough.

    hustlermoneyblog December 15th, 2006 at 10:17 pm
  • Would you please explain how did you get the EV $283.5 billion figure?
    Exactly what did you put into which forumla?
    Thanks
    Bid

    Bid666 December 16th, 2006 at 4:11 am
  • sirs

    i’m not satisfied with pfe dec. to sell the consumer div for 16 billion

    more $ for stock-holders if they spun them off into 2/3 co’s and issued stock to the stock-holders.

    i will not support the board of dir on this mve.
    next election i will vote for others not them.

    your thoughts on this??????
    al goodwin 207-726-5574 pfe stock-holder in maine

    al goodwin December 16th, 2006 at 11:50 am
  • sirs;
    thank you
    didnt think you were this quick
    i’m interested in other pfe holders concerns on this issue of sale of consumer div.

    16 billion from jnj before yr end
    what to do with it
    buy back stock?????thinkl not
    massive dividend its our money why not//
    thanks again
    al goodwin

    al goodwin December 16th, 2006 at 11:54 am
  • Solid analysis. I love using discounted cash flow models to evaluate stocks, especially large value plays like Pfizer.

    I’d like to add a few reasons to hold their stock.

    1. 0.12 debt-to-equity ratio and current ratio of 2.2. The company’s debt and assets are well managed.

    2. P/E is trading around its 5-year low

    3. Price/Book is sub-3, the industry average is nearly 5.

    4. Institutional ownership is only 2/3 of the company.

    Once again, you picked a winning stock. Keep the good stuff coming, george.

    TJP December 19th, 2006 at 2:00 pm
  • sirs;

    imagine it mon a.m. the co gave us (stock-holders) another nickle per qtr.
    did they read my blog here.
    they put in new c.e.o. as well

    REALLY INSUFFICIENT a 3.00$ one time div. would only cost less than 5 billion, there getting 16 billion end of dec from jnj for the consumer prod div sale wowowowo.

    3what a deal for someone—not us,nickle is a joke on them.

    i will still be defeating the board at the next meeting, all must go to save our co.

    thanks
    al goodwin 12/19 06

    al goodwin December 19th, 2006 at 2:49 pm
  • wed.dec.20,2006
    what a day today for pfizer
    jnj paid out 16.5 billion
    pfe paid our uncle sam over 3 billion taxes
    left 13.5 billion

    OUR MONEY,THEY SAY WILL INVEST IN GROWTH OF ITS CORE BUS. AS WELL AS DECLARE DIVIDENDS AND SHARE PURCHASES.
    WOWOWOWOWO WHAT A DEAL FOR WHO?

    I want to know what the stock-holders get i expect a 6inch long sqr peg

    i cant wait to get my voting material for next share-holders mtg.

    off with there heads,let them eat cake, the board better be looking for jobs cause there HISTORY….ALL GOTTA GO.
    spread the word all stock vote against the dir3ectors

    thanks for the site

    al goodwin
    algoodwin@midmaine.com

    al goodwin December 20th, 2006 at 7:35 pm
  • hey folks
    al goodwin again
    imagine
    dec 21
    first day of winter
    pfe latest news HANK MCKINNEL WILL GET 200 MILLION TO LEAVE
    I HEARD HE LEFT MONTHS AGO
    THEY JUST FILED THE $$$$$#

    BIG PAYOFF FOR HANK

    I TELL YA LETS GET THIS BOARD GONE AT NEXT MTG OR THERE WOONT BE NUTTIN LEFT OF THE 13.1 BILLION THEY COLLECTED FROM JNJ. THIS WEEK.

    GOTTA GO
    KEEP TABS ON THIS

    AL GOODWIN

    al goodwin December 21st, 2006 at 7:38 pm
  • sirs

    now getting .29 a quarter
    lets blog the hell out of them maybe we can get real value for out pfe stock.

    thanks for putting my replys on
    need moore people to hit em hard
    its our co.
    lets take it back
    al goodwin

    al goodwin May 14th, 2007 at 3:33 pm
  • When you know Free cash flow of PFE?
    I only data from year 2000.
    Can you send me data before year 2000 Free cash flow?
    Thanks

    pedro July 17th, 2010 at 6:49 pm

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