Global biopharmaceutical company AstraZeneca (LSE:AZN) has done very well this year. The AZN share price is up 42% since the March stock market crash. This is because it has developed a strong portfolio of products to combat some of the world’s most prevalent diseases. This includes medicines for cancer, gastrointestinal disorders, neuroscience, cardiovascular conditions, respiratory troubles, infection and inflammation.
With the coronavirus resulting in many of these ailments, particularly infection, respiratory issues, and inflammation, the AZN share price has soared. It has enjoyed a string of positive headlines with drug trials going well and orders coming in. However, pharma is a volatile industry where trials often fail. It pumps enormous volumes of cash into research and development, and not every speculative development creates a cash cow.
Is the AZN share price overvalued?
Consumer confidence has risen in AstraZeneca because it sells vital drugs and because pharmaceuticals are a necessary purchase even in times of recession. However, the AZN share price has now reached a point that seems overvalued, compared with its profit margin and ongoing R&D costs.
A useful gauge of company value comes in the price-to-earnings ratio (P/E). It has long been a part of the value investor’s analysis of suitable stocks to buy. Benjamin Graham and Warren Buffett used it to assess a company’s intrinsic value, along with dividend yield and earnings growth.
The P/E is the ratio of a company’s share price to the company’s current or forecast earnings per share. The AZN share price is £84.45 and current earnings per share are 82p. This means the P/E is £84.45/£0.82 = 102.
To give you a sign of how this relates to value, according to the Benjamin Graham playbook, a good P/E is 10. Above 15 is likely overvalued and below 10 potentially undervalued.
With a P/E of 102, the AZN share price is clearly overvalued. Putting it in perspective — to sustain this ridiculously high P/E AstraZeneca would need to maintain a healthy growth rate of over 20% a year for at least 10 years. Even for an international pharma/biotech conglomerate, this seems an optimistic goal to me.
Is AstraZeneca a recession-proof stock?
Fears of a global recession are mounting, and while various government grants, loans, and bailouts are so far keeping the economy afloat, this is unlikely to last. Forecasts from the Organisation for Economic Cooperation and Development show the UK economy will contract by 11.5% this year. But this could rise to 14% if a second wave of the coronavirus returns later in 2020. This does not bode well for the stock market, and I think another market crash is likely.
In March, the AZN share price fell to a low of £59. Following this, it steadily rose to breach £90. Press reports in June cited AstraZeneca had reportedly approached Gilead about a potential merger. This caused the AstraZeneca share price to fall, and it has since been faltering around the £84 mark. I think a second market crash would send it spiralling again.
There is no doubt AstraZeneca is a good, strong company and I believe it will thrive long into the future. But the AZN shares are not a bargain at today’s prices. Its dividend yield is a paltry 2.5% and I think it could well be at risk of a share price correction. There are other recession-busting FTSE 100 stocks I like the look of, including SSE.
Kirsteen has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.