This month’s dividend growth stock is Amgen (AMGN). Amgen is one of the world’s leading bio-technology companies. Amgen studies biological mechanisms in search of therapies for serious diseases, then manufactures and distributes the drugs that it discovers and develops. Amgen’s sales in fiscal 2016 were about $23 billion, and it spent close to $4 billion on research and development.
Amgen’s Dividend Record
This is a very good dividend resume.
Amgen’s yield of 2.8% is not extremely high, but it qualifies as “enough” for most dividend growth investors.
The company began paying a dividend in 2011.
I have no concern about the declining dividend growth rate, because it started from such a high rate to begin with.
(Amgen’s first increase, in 2012, was more than 150%.)
There is almost no risk of Amgen’s dividend being cut any time soon. Indeed, the company is just about to pay a 15% increase for 2018. (For more insight on dividend safety, see Dividend Growth Investing Lesson 17.)
Amgen’s Business Model and Quality
Amgen discovers, develops, manufactures, and delivers human therapeutics based on the science of human biological processes.
Amgen was formed in 1980 and went public in 1983. Originally called AMGen (which stood for Applied Molecular Genetics), it has grown to be one of the world’s leading independent biotech companies, reaching millions of patients in about 100 countries.
Amgen takes a “biology first” approach, using cutting-edge science and technology to study human biological mechanisms in search of therapies for diseases. Amgen’s approach is to understand the fundamental biological mechanisms of disease in order to determine what type of medicine is most likely to deliver optimal efficacy and safety.
Amgen focuses on 6 areas (with leading drugs shown as examples):
• Bone health (Prolia, Xgeva)
• Cardiovascular (Repatha, Epogen, Aranesp)
• Oncology/Hematology (Neulasta, Nexavar, Kyprolis)
• Inflammation (Enbrel)
Amgen’s medicines typically address diseases for which there are limited treatment options or that provide a viable option to what is otherwise available. Amgen has leading drugs in all of its focus areas, with more in various stages of development.
Amgen expects its current lineup of drugs to continue to contribute to its financial success.
[Source of slides: Amgen presentations]
Amgen’s growth strategy is based on the development of new patented drugs, biosimilars for drugs already on the market, and international expansion.
As advances in human genetics continue to shed new light on the molecular roots of disease, Amgen’s subsidiary deCODE Genetics, which is a global leader in human genetics, greatly improves how the company identifies and validates human disease targets.
Amgen is also a worldwide leader in the safe and reliable production of biologic medicines, which are administered by injection or intravenously. The company considers robust quality control and the production of a reliable supply to be as important as scientific innovation.
One of Amgen’s competitive threats over the years has been “biosimilars,” which are drugs that are approved based on showing that they are highly similar to existing approved products and have active properties similar to ones that have previously been licensed. However, unlike generic medicines in which the active ingredients are identical to the reference drugs, biosimilars are not identical due to such factors as the inherent complexity of biologics and proprietary details of the reference products.
Earlier in this decade, Amgen committed itself to leveraging its extensive biotechnology experience and core capabilities to create high quality biosimilars. The company expects biosimilars to be an important growth driver in the future. Ten biosimilars are currently under development. MVASI is the first anti-cancer biosimilar approved by the FDA, and it is also under review by the European Medicines Agency (EMA). In 2017, Amgen reached a global settlement with AbbVie to resolve all pending litigation regarding AMGEVITA, a biosimilar to AbbVie’s Humira.
In late 2018, Amgen expects to begin commercializing its own biosimilars, beginning with AMGEVITA. That will provide a new revenue stream, which should grow as other biosimilars now in the pipeline come to market.
Amgen gets an A++ financial grade from Value line, and when you look at the details, you can see why.
Return on equity (ROE), which is a measure of profitability, is good at 26%. Not only that, it has been gradually growing over the past 10 years.
[Source of all yellow-bar graphs: Simply Safe Dividends]
Amgen’s earnings growth over the past 5 years has been a stellar 21% per year. The company has had positive earnings growth in 9 of the past 10 years. The only weak point in Amgen’s earnings picture is the consensus estimate of only 4% growth over the next 3-5 years. Note that in their own presentation, Amgen expects double-digit earnings growth on average.
For several years, Amgen has been implementing cost-cutting efficiency programs. As noted in the slide above, cost savings have reached $1.5 billion, and operating margins have improved significantly. The company’s cash flows have been consistently positive and growing gradually similarly to its earnings.
The last line in the display, returning cash to shareholders, refers to Amgen’s dividend and share buyback programs.
Amgen is a consistent generator of free cash flow, which is the cash a company has left over after paying its expenses. Excess cash flows allow a company to pursue investment opportunities, make acquisitions, repurchase shares, and pay/increase dividends. The following chart shows Amgen’s strength as a cash flow generator.
The strong cash flow is one of the reasons that Amgen’s dividend is considered so safe.
Another financial improvement has been in Amgen’s debt picture, with long-term debt gradually declining for several years.
The debt-to-capital (D/C) ratio sits at 49%, which is about average these days.
Overall, Amgen presents a very solid financial picture.
Amgen’s Stock Valuation
My 4-step process for valuing companies is described in Dividend Growth Investing Lesson 11: Valuation. Let’s go through the steps.
Step 1: FASTGraphs Basic. The first step is to compare the stock’s current price to FASTGraphs’ basic estimate of its fair value.
The basic valuation estimate uses a standard price-to-earnings (P/E) ratio of 15, which is shown by the orange line on the following chart. The black line shows Amgen’s actual price. I’ve circled Amgen’s actual P/E ratio.
The actual P/E ratio of 14.9 is almost identical to the value of 15 that was used to draw the fair-value line. Thus Amgen’s price sits just a tiny bit below the orange line.
The ratio of the P/E’s tells us how far below: 14.9 / 15 = 0.99. The current price is just 1% below the fair price as calculated by this first method.
The fair price would be $191 under this approach, just a little above what the price actually is.
Step 2: FASTGraphs Normalized. The second valuation step is to compare Amgen’s price to its own long-term average P/E ratio. This gives us a picture based on the stock’s own long-term valuation instead of the market’s long-term valuation.
On the next graph, the blue fair-value line is drawn at a P/E of 14.4, which is Amgen’s 5-year average P/E ratio.
Viewed from this perspective, Amgen is a tiny bit overvalued. The degree is computed the same way: 14.9 / 14.4 = 1.03, or 3% overvalued. This suggests a fair price of $183.
Step 3: Morningstar Star Rating. Morningstar uses a discounted cash flow (DCF) process for valuation. Their approach is comprehensive and detailed. Many investors consider DCF to be the best method of assessing stock valuations.
In their approach, Morningstar ignores P/E ratios. Instead, they make a detailed projection of all the company’s future profits. The sum of all those profits is discounted back to the present to reflect the time value of money. The resulting net present value of all future earnings is considered to be the fair price for the stock today.
Morningstar considers Amgen to be fairly valued, as shown by their 3-star rating on their 5-star scale. Their estimated fair price is $193.
Step 4: Current Yield vs. Historical Yield. Last, we compare the stock’s current yield to its historical yield. This is an indirect way of calculating fair value, based on the idea that if a stock’s yield is higher than normal, it may indicate that its price is undervalued (and vice-versa).
According to Morningstar, Amgen’s 5-year average yield has been 2.1%. The current yield of 2.8% is 33% higher than that, suggesting the stock is significantly undervalued.
In this 4th method, I cut off the difference at 20% to be conservative. At 20% undervaluation, Amgen’s fair price would be $236.
Thus, I conclude that Amgen’s current price is about 6% below its fair price. I consider anything within 10% of fair value to be “fair.”
Beta measures a stock’s price volatility relative to the S&P 500. I like to own stocks with low volatility, because they present fewer occasions to react emotionally to rapid price changes, especially sudden price drops that can induce a sense of fear. There is also academic research that suggests that low-volatility stocks outperform the market over long time periods.
Amgen has not been a low-volatility stock, with 5-year beta of 1.4 compared to the market as a whole at 1.0. That means that its price moves about 40% more than the market on average. This is a negative factor.
In their report on Amgen, CFRA shows the recommendations of 27 analysts who cover Merck. Their average recommendation is 3.7 on a scale of 5. This translates to nearly a “buy.” This is a positive factor.
Share Count Trend
You may recall from an earlier display that Amgen has an active share buyback program in place. This has resulted in a significant decline in outstanding shares over the past 10 years, although the rate of decline has slowed over the past few years.
I like declining share counts, because the annual dividend pool is spread across fewer shares each year. That makes it easier for a company to maintain and increase its dividend.
Here are Amgen’s positives:
• Excellent dividend resume: Decent yield at 2.8%; strong dividend growth rate; 15% increase this year; and strong dividend safety, protected by very good cash flow. The only weak spot is the short streak of increasing dividends (7 years).
• Stock is slightly undervalued.
• High quality company with wide moat and strong credit rating.
• Good pipeline of drugs in development, including biosimilars.
• In midst of cost-cutting program as well as programs to improve manufacturing efficiency and buy back shares.
• Good financials, including high return on equity, strong cash flows, and moderate debt.
Here are the negatives:
• Highly competitive market.
• Slow earnings growth of 4% per year projected for next 3-5 years.
• Above-average price volatility.
Overall, I see Amgen as a strong candidate for investment. It will be in the running for the next dividend reinvestment in my Dividend Growth Portfolio.
That said, this is not a recommendation to buy, hold, or sell Amgen. Any investment requires your own due diligence. Always be sure to match your stock picks to your personal financial goals.
— Dave Van Knapp
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