World's Scariest Stocks: Pfizer

In this series, you'll find companies with scary valuations, scary prospects for growth, and financial stocks with scary volatility. But here's what I find really scary: the unknown. Ghost and goblins are frightening, but hearing them without actually seeing them is a lot moreso.

For Pfizer (NYSE: PFE), that big unknown comes from whether it can integrate its recent acquisition of Wyeth, make the cost savings justify the expensive purchase, and grow revenue and earnings on the other side of the integration.

Keeping it real
Here's what isn't too scary, unless you're a shareholder: Pfizer's current price. The shares are essentially flat, compared with a 29% increase in the S&P 500 since a rumor of the merger first appeared. Maybe that means there's a lot of value built into the stock. Maybe not.

Worse yet, it's very difficult to tell whether the megamerger will pan out. The only thing investors have to go on is history, and that, fellow Fools, is very scary indeed.

A double whammy
In the first half of the decade, Pfizer made two major acquisitions: Warner-Lambert in 2000 and Pharmacia in 2003. Through both its own growth and those acquisitions, the company grew revenue from $27 billion in 1999 to nearly $49 billion in 2004.

Its stock price, on the other hand, tells a different story. The stock peaked at a hair above $50 per share 14 months before the acquisition of Warner-Lambert closed, reached $49 a month after that deal closed, and hasn't come close to reaching that level since. Then again, it's certainly not been the only drug company that's had problems satisfying shareholders.

Source: Capital IQ, a division of Standard & Poor's. Returns exclude dividends.

Sure, Pfizer investors have gotten $7.22 in cumulative dividends since then, but that hasn't made up for the drop in price over the past nine years. In addition, Pfizer cut its dividend in half this year to retain cash to pay for the Wyeth acquisition.

Now, it's always possible that the company will increase the dividend next year, but that may not provide much of a floor for the stock price. After all, the dividend yield was 7.3% before Pfizer's announcement that it would acquire Wyeth. Even if the company ups the dividend to $0.80 annually, the share price would have to fall below $11 before it would have that dividend yield again.

The bigger they are, the harder they grow
The reason for the drop seems simple enough to me: Research and development doesn't scale all that well. Revenue has been essentially flat from 2004 through last year, and it's down so far this year, burdened by a strengthening dollar. More importantly, new products haven't been enough to make up for older drugs on the decline, because of competition from generics or the approval of better drugs. (To be fair, the company sold its consumer-health division to Johnson & Johnson, in a move that decreased revenue by about $4 billion.)

The added revenue from new drugs looked good on paper, but the company seems to need an increasing number of new drugs to grow revenue significantly. After all, a new $1 billion blockbuster drug doesn't increase the top line all that much for a company bringing in $49 billion annually.

The other problem is the limited number of treatment areas available to increase revenue. New drugs have to be much better than the current standard of treatment. Even then, they can cannibalize older drugs still being sold, and thus don't add as much new revenue. For example, Eli Lilly recently decided to not seek approval for its osteoporosis drug, even though it passed its phase 3 trial. The drug wasn't much better than what's currently available (including Lilly's own drug) and the side-effect profile wasn't as good.

© 2009 UCLICK L.L.C.