While value investing is a highly profitable strategy that has stood the test of time and has been employed by many famous fund managers, one ruler I typically use to separate the wheat from the chaff is the 80% decline rule.
This rule means that unless the overall market has declined by 40% or more in the given period that an individual stock has corrected, stocks declining 85% or more from their all-time highs should be avoided.
The rule aims to steer clear of stocks with serious issues in their long-term business model or a major flaw which can often be weeded out simply by avoiding any stocks that have declined by this magnitude.
The reason is that any stock with strong institutional support and a phenomenal business model should not decline this significantly, especially if the market is not in a secular bear.
That said, there are rare exceptions to this rule, and this can sometimes occur if a stock gets way ahead of itself and then must come back to reality with a violent multi-year correction.
One example is Netflix which came just shy of the 85% mark after peaking in 2011, and another that could be an exception is Perrigo Company PLC (PRGO).
This stock has continued to move to the top of many deep-value scans over the past month and recently touched the 86% decline mark.
However, this was partially due to trading at exuberant levels in 2015 at bubble-like valuations and having to unwind this excess.
Too Much Negativity Breeds Buying Opportunities
Perrigo is a $4.4 billion consumer self-care company that sells private label over-the-counter pharmaceuticals with products for nutrition, skincare, personal hygiene, pain and sleep aids, oral self-care, and upper respiratory.
The company was founded in 1887 in Michigan (but is based out of Ireland) and generated $4.1BB in revenue last year, with ~70% of sales from the United States.
However, while sales were up year-over-year, they have declined for years relative to peak revenue of $5.28BB in FY2016, and earnings have seen an even sharper decline.
In fact, Perrigo’s annual earnings per share [EPS] has plummeted from $5.07 in FY2015 to $2.06 in FY2021, and annual EPS estimates are expected to decline again this year (FY2022 estimates: $2.02).
This multi-year trend of negative EPS has contributed to an 86% decline in the stock when combined with it previously trading at a bubble-like valuation of 33x earnings at its 2015 peak.
The result is that from a sentiment standpoint, nearly every long-term investor purchasing the stock since 2010 is sitting at a loss, providing a great contrarian setup as some investors throw in the towel for good, and many will never be back, no matter how cheap the stock becomes.
However, even though the FY2022 outlook for the stock isn’t great, with another decline in annual EPS ($2.02 vs. $2.06), the forward outlook is considerably better.
This is based on an expected margin improvement in FY2023, increased sales with Perrigo purchasing Nestle’s Gateway infant formula plant and planning to increase production, plus the benefit of consumers on tight budgets potentially trading down to generic brands for their self-care needs.
It appears quite clear that annual EPS has hit its trough and is headed much higher (FY2023 estimates: $2.75). Given that the market is forward-looking, this should help the stock begin a new sustainable uptrend.
The Fundamental Case
From a valuation standpoint, PRGO trades at ~16.3x earnings FY2022 earnings estimates at a share price of $33.00, which doesn’t offer much of a discount relative to other companies in its industry group and those selling generic pharmaceuticals and self-care products.
However, this earnings multiple is based on expected trough earnings of $2.02 in FY2022, and if we measure using FY2023 earnings estimates of $2.75, which are more relevant, PRGO trades at a deep discount to its historical multiple (16.6) at just 12.0x earnings.
Not only is this current multiple a massive discount vs. its peer group and its historical multiple, but PRGO is in a position to increase annual EPS by more than 70% from FY2022 to FY2025 based on current estimates.
I would expect this major reversal from earnings declines to an earnings recovery to result in a sharp increase in its multiple, with the stock potentially going back to trading at 18-20x earnings like it did in its previous long-term uptrend.
In this case, PRGO could be a $50.00+ stock by 2025, and investors are locking in an attractive 3.2% yield.
The Technical Setup
PRGO’s technical setup has left lots to be desired for years, with the stock continuing to make new lows and unable to reclaim its 30-month moving average on a monthly closing basis.
However, we appear to be seeing a turnaround over the past month, with five tight weekly closes in a row that suggests accumulation and the stock soaring above its 25-day moving average last week on increasing volume and finishing a rough week for the market at a new 20-day high.
While these don’t fix the long-term picture, and PRGO remains in a downtrend, this subtle character change looks very positive.
This potential reversal has occurred with the stock sitting at a pivotal multi-year support level as it re-tests prior resistance from its previous multi-year breakout.
So, with PRGO reversing at an important level and this defensive stock being the cheapest it’s been in over a decade, it is a rare mix of value and momentum if this rally can continue, pushing it back above its 50-day moving average ($34.50).
The Bottom Line
Based on what I believe to be a conservative earnings multiple of 14.1 (20% discount to PRGO’s 10-year average PE ratio of 16.6) and FY2023 annual EPS estimates of $2.75, I see a fair value for the stock of $38.80, pointing to 18% upside from current levels.
However, this does not include a 3.2% dividend yield, and I see these estimates as achievable and potentially beatable, suggesting this is a conservative price target with a total return of 21%.
If we look out to FY2024, annual EPS is expected to increase another 20% to $3.30 per share, with the same multiple translating to a 2-year target price of $46.50.
This would translate to more than 47% upside on a total return basis from its current share price of $33.00, a very attractive return for a relatively safe stock in a more defensive sector.
And, looking ahead to FY2025, annual EPS estimates are sitting at $3.60, suggesting even further long-term upside and a clear end to this negative earnings trend.
I see PRGO as extremely undervalued at current levels and one of the best turnaround stories in the market.
In summary, I would view any weakness in the stock as a buying opportunity, and I would not be surprised to see the stock trade above $39.00 in the next 12 months.
Disclosure: I am long PRGO
The above analysis of Perrigo Company PLC (PRGO) was provided by financial writer Taylor Dart. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Is Perrigo Company PLC (PRGO) A Buy or Sell?
Based on MarketClub’s technical analysis tools, Perrigo Company PLC (PRGO) is showing signs of short-term weakness, but still remains in the confines of a long-term uptrend. Keep an eye on PRGO as it may be in the beginning stages of a reversal.
MarketClub is analyzing every data tick, ready to spot a new trend as it develops.
Get an alert when PRGO triggers a new signal and analysis for over 350K markets with a 30-day MarketClub trial.