Is COH Overvalued?

CSL, COH (and other pharma and biotechs) often have very high PEs leading many to think they are overvalued, but are they?


Australian accounting standards require R&D to be expensed to the P&L when incurred (the exception is software R&D). This implies that there is no immediate value to the R&D spend given the uncertainty in the outcome and therefore results in a more conservative, lower profit figure. However, there is a school of thought that R&D spend should be capitalised as an asset on the balance sheet and amortised in the P&L over its useful life even though the lag time from R&D to commercialisation is often decades or not at all. The trick is then to correctly value the R&D on the balance sheet so that the amortisation costs flow through to the P&L. In theory this would result in a higher profit figure.


If applying PEs to value biotechs and pharmas (which typically have a high R&D spend) is suspect, what is the appropriate valuation methodology? Incidentally, Warren Buffett does not consider the PE ratio a valuation measure.


Using a discounted cashflow methodology is not without its cons. Estimating a 10 year (I have heard some fund managers using a fifteen year estimate) cashflow into the future is next to impossible to obtain with any degree of certainty and accuracy. Hands up all those who predicted COH’s half year profit to within $1M.


So is COH overvalued? Well, maybe, maybe not….. But I also think CSL and COH command a premium due to the quality of its earnings (high profit margins and real cashflows) and the dominant position it commands in most of the businesses they operates in.


What do you think?



Disclosure: I am long CSL and COH