- It doesn’t matter what the PE Ratio is – Gilead is not necessarily undervalued at present prices.
Many value investors seem to be enamored with Gilead because it is trading at a “low PE.” However, looking at uncertainties related to opportunities for Gilead’s future growth and considering that its single largest revenue source – its hepatitis c virus (HCV) treatment franchise – is likely to continue to shrink in the near-term, we believe the present price is easily justified by fundamentals. Using a PE ratio or any other multiple to value a firm only obfuscates assumptions for the rate of growth of future cash flows. Gilead’s shares are a perfect case in point why multiples-based valuations are often deeply flawed.
We do find several scenarios where Gilead’s intrinsic value would be considerably higher than its price is trading today, but also one where it’s value is about 34% lower than it is today. We are unable to handicap the likelihood of these outcomes, but upside scenarios are slightly undervalued by the option market.
- Gilead is essentially a very specialized, highly-regulated biotechnology hedge fund.
A hedge fund engages in proprietary financial research and invests capital in investments that it believes has the best chance of generating large cash flows within its investment time horizon (which is usually determined by its investors). Most hedge funds are only lightly regulated, but are subject to legislative risk.
Gilead engages in proprietary biotechnological research and invests capital in investments that it believes has the best chance of generating large cash flows within its investment time horizon (which is legally determined by patent law). Gilead is in one of the most tightly regulated industries in the world and is subject to regulatory and legislative risk.
Gilead’s product portfolio (equivalent to a hedge fund’s investment portfolio) is highly concentrated in two related areas – treatment of HCV and of HIV. As any investor who has studied Bill Ackman or Bill Miller’s career will know, concentration is a double-edged sword. Gilead’s investments throw off a lot more cash than Ackman’s or Miller’s do, and in that respect, are much more robust. However, if Gilead’s future investment projects are not very successful, the company’s value is less than its present price.
- Investment success hinges upon factors that are impossible for anyone alive to know today.
Gilead’s business hinges on its ability to consistently invest in research or acquisitions that will generate blockbuster drugs in the future. We think that Gilead may have an advantage in assessing antiviral drugs, but even with this acuity, commercial success relies upon what its competitors are doing and the results of trials and regulatory reviews. Many opine. No one really knows.