The high spending on research worked out and unlocked high profitability for this pharmaceutical company
With increasing research and development spending, the pharmaceutical sector continues to grow and innovate.
One of the highest growth can be seen in the oncology area. These drugs require extensive research and many clinical trials, making them expensive and profitable.
One company that managed to unlock this high profitability is Exelixis (EXEL). Its successful oncology products allow it to mint money.
However, the market does not think that this profitability will be sustainable, causing the name to be undervalued.
That’s why Exelixis showed up on our FA Alpha Screen. The market’s lack of understanding of the sustainability of its high returns and its low valuation makes it a great candidate for FA Alpha 50.
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The pharmaceutical sector keeps evolving and saving lives.
It is one of the industries with the highest research and development (“R&D”) spending, and that allows companies to develop new drugs to battle common and rare diseases.
The total U.S. spending on pharmaceutical research has increased almost every year since 1995. We spent $102 billion in 2021, compared to $26 billion in 2000.
Of course, different areas of the industry grow at different paces.
Oncology, for example, has seen incredible growth in the past years.
Oncology drugs play a critical role in the pharmaceutical industry, as they are crucial in treating cancer, one of the leading causes of death worldwide.
Cancer treatment has advanced significantly in recent years, and new and innovative oncology drugs have played a significant role in these advancements.
The development and production of oncology drugs is a complex and expensive process, requiring extensive research and clinical trials.
This makes oncology drugs some of the most expensive drugs on the market, but they are also some of the most profitable, as the demand for cancer treatments is high.
In addition, many oncology drugs are patented, which gives pharmaceutical companies exclusive rights to sell the drugs, further increasing their profitability.
One of these companies benefiting from this is Exelixis (EXEL). It focuses on the discovery, development, and commercialization of new medicines to treat cancers.
The company has seen significant growth in recent years due to its investment in research and development of successful products.
Its Uniform return on assets (“ROA”) surged from below 9% in 2018 to 33% in 2020. It has been stable at around 24% for the last two years.
Even after the pandemic, Exelixis continues to be profitable with its vital drugs for cancer treatment.
However, the market does not believe this high profitability is sustainable, and prices it to go down.
Even after the boost in profitability after 2018, both price-to-earnings (“P/E”) and price-to-book (“P/B”) ratios continued to fall consistently. Current levels are the lowest since 2016.
Given the successful R&D spending and essential medicines for one of the biggest causes of death, this outlook seems too pessimistic.
The market’s lack of understanding of the sustainability of its high returns and low valuation means that Exelixis is a great FA Alpha 50 candidate.
Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.
Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”
Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.
The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.
The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.
That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.
This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.
See for yourself below.
To see the other 49 names on the list, click here.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research