Pharmaceutical stocks are both growth and income plays, so today I’ll look for the cheapest pharmaceutical stocks in the stock market.

By “cheapest”, I want stocks that sell at a discount to intrinsic value. That can be challenging in this market, because many pharmaceutical stocks pay dividends, and investors have been chasing dividend stocks since the Fed cut interest rates so drastically.

The other pitfall of pharmaceutical stocks right now is that they are perceived as safe blue-chip stocks. As a result they get bid up higher than their intrinsic value, but carry additional risk for being overpriced simply because of their perception of safety.

So we need to be circumspect in our choices, and find those pharmaceutical stocks that are in solid financial shape, have good cash flow to pay dividends, but which are not overpriced.

So we must be vigilant and remind ourselves that we are looking for both the cheapest pharmaceutical stocks, and ones that are not subject to the above pitfalls.

The Cheapest Pharmaceutical Stocks For 2019

If you’re in a hurry, below are our picks for the most lowest priced pharmaceutical stocks as of this writing.

1. Pfizer: A legacy player in the midst of a second wind.
2. Teva Pharmaceutical: A beaten down player with big turnaround potential.
3. Novartis: A leader in biosimilars, the next big thing in drug making.

Keep reading to learn more about these inexpensive pharmaceutical stocks and my thoughts on them.

What Are Pharmaceutical Stocks?

Pharmaceutical stocks are companies that can do any or all of the following; research new drugs; develop new drugs; and manufacture, market, and distribute drugs.

Pharmaceutical products can take up to ten years or more to develop and put to market. That’s because it takes enormous scientific and capital resources to understand why a disease afflicts humans, target the bodily mechanisms that cause it, and then figure out how to manipulate those mechanisms with different therapies.

Then they have to be tested endlessly for both safety and effectiveness. Then they have be run through an entire marketing analysis.

About 90% of drugs fail, because the Food and Drug Administration has a high barrier to hurdle to prove that drugs work and are safe.

There’s also the issue of determining which diseases to put money into to find a cure. Not all diseases have a big base of consumers. Not only that, the ones that do are subject to competition from other pharma companies.

The cheapest pharmaceutical stocks will be that way because they are growing at a solid rate and investors haven’t quite bid them up high enough.

Read Also: What’re The Cheapest Dividend Stocks?

How Do You Determine What Qualifies As The Cheapest Pharmaceutical Stocks?

The cheapest pharmaceutical stock shave these three characteristics:

1. Trading at a PEG ratio of 1.5 or less.
2. Long history of strong cash flow.
3. Substantial new product pipeline

PEG Ratio of 1.5 or less

If you are going to invest in the cheapest pharmaceutical stocks, then those stocks must sell at a price to earnings ratio that is no more than 50% higher than their long-term projected earnings growth rate. That’s because stock prices follow earnings, and if the price is too far ahead of earnings, then the stock is overvalued.

In most cases, I consider cheap stocks to be those with a PEG ratio of 1.0 or under.

However, because few pharma stocks actually trade at that low a PEG ratio because they tend to be growth companies that permit higher multiples, so I permit these stocks to at a premium.

With a PEG ratio, I take the company’s total cash position, subtract long term debt, and then subtract that net from the company’s total market cap.

I also permit a 10% premium for companies with a substantial cash position, 10% for world class brand names, and 10% for companies with long term and robust free cash flow.

Long history of strong cash flow

Cash flow isn’t a direct component of an earnings valuation calculation. However, it is a requirement for overall company health and a general indication about overall value.

There are ratios that measure stock price to free cash flow. While what is considered “cheap” can vary with this metric, the more cash flow a company has, the smaller that ratio is, and smaller is better.

New product pipeline

Diversification is king in just about every business. All pharmaceutical companies not only need several drugs in the market, but also several in development, thanks to the high failure rate.

A pipeline provides both future cash flow and future earnings. If a pipeline is weak, then the company could face earnings and cash flow shortfalls in a very competitive market.

This is a version of portfolio theory, and is critical in providing flexibility as far as a company’s overall long term strategy.

Here’s a video that helps you with investing in pharmaceutical stocks that are heading for FDA consideration.

Pfizer

What is it?

Pfizer is a pharma company with two major divisions: Innovative Health and Essential Health. The former focuses on the development and sale of medicines and vaccines, as well as consumer healthcare products in many therapeutic areas.

The latter offers products that have lost patent protection, which includes branded generic products, generic sterile injectable products, and anti-infection drugs.

Pfizer has several blockbuster drugs to its credit, including Prevnar, Lipitor, Lyrica, Celebrex, Viagra, and Enbrel.

What makes it a cheap stock?

Pfizer had been struggling for a number of years, as drugs went off-patent and its pipeline was weak. It also made a bad move in purchasing Wyeth, which burdened the company with tons of debt.

But Pfizer has bounced back, partially because it was supported during the bad times by – guess what? – strong free cash flow.

Pfizer has pegged a lot of success in its Essential Health Segment through the development of biosimilars.

Generic drugs have provided life-changing pharmaceuticals to Americans for years, at a discount of as much as 90% off the brand-name price, and created a multi-billion dollar generics industry. Generic drugs are effectively identical to their branded counterparts, and created through specific chemical processes, resulting in a fixed molecular structure.

Thenew creation called “biosimilars”are essentially the generic version of “biologics”.

To date, more and more are coming to market, making life-saving cancer and autoimmune biologics available at discounts.

According to IMS Health, U.S. biologics spending hit $92 billion in 2013. The Rand Corporation collated estimates suggesting that consumers would spend as much as 40% less on biosimilars over time, putting as much as $44 billion back into citizen’s pockets.

There’s more than just affordability at stake. Aside from making these drugs more affordable, biosimliars represent a desperately new source of revenue for biotech and pharmaceutical companieslike Pfizer.

Pfizer trades at a PEG ratio of 1.4, factoring in 10% premiums for meeting all the criteria mentioned earlier.

Its free cash flow is simply fantastic and has been for decades, routinely generating between $13 billion and $16 billion annually.

Read Also: What’re The Best Income Stocks?

Teva Pharmaceutical

What is it?

Teva in an Israel-based company that is the worldwide leader in generic drug manufacturing, marketing, and distribution. It also creates some original drugs.

Its flagship drug is Copaxone, which treats multiple sclerosis. It also created AUSTEDO for symptoms associated with Huntington disease. It has several products for the respiratory market including ProAir, QVAR, Cinqair, and Aerivio. It also has several products in the oncology market.

What makes it a cheap stock?

Teva has subsidiaries all over the globe. However, it has had some struggles. Forty states and several generic drug companies are suing Teva for alleged price fixing. Copaxone is now off-patent. The CEO had to vacate his position in 2017 because the DOJ was looking into alleged bribery claims.

Teva also made a very poor acquisition in Actavis, which loaded more than $20 billion of debt onto the company.

Lost in all of this is that Teva is a cash generating, profitable business, and the biggest generics manufacturer in the world. All of this bad news will eventually go away, and none of it has to do with the business itself, except digesting the Actavis deal.

Free cash flow has always been robust, with more than $4 billion generated every year – although that is down to $2.6 billion this past year.

I was said to see it suspend its dividend, but it will return at some point, and the cash is useful for the business right now. More importantly, it continues to have operating profits, and it is trading at a price not seen since 2002.

I consider Teva to be at the top of the list of cheapest pharmaceutical stocks.

Novartis

What is it?

Novartis probably has the most diverse lineup of therapies of these three stocks. They work in pharmaceuticals, biosimilars, and biotech. They hit all the big disease arenas: immunology, dermatology, oncology, neuroscience, respiratory, cardiovascular – the list is endless.

What makes it a cheap stock?

Novartis is the classic pharmaceutical stock that is running at full speed. It has boatloads of drugs both in the market and in its pipeline, is fully diversified both in terms of product and geography, and it makes enormous profits.

Novartis has generated over $52 billion in net income since the start of 2014. That’s incredible. Along with that, free cash flow remains consistent, coming in between $2.2 billion and $3.6 billion each year.

The great strides Novartis is making is what qualifies it as one of the cheapest pharmaceutical stocks.