Vertex Pharmaceuticals trades at $500.94 and has moved in lockstep with the market. Its shares have returned 5.5% over the last six months while the S&P 500 has gained 1.6%.
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We're cautious about Vertex Pharmaceuticals. Here are three reasons why we avoid VRTX and a stock we'd rather own.
Why Is Vertex Pharmaceuticals Not Exciting?
Founded in 1989 to focus on a broad range of diseases, Vertex Pharmaceuticals (NASDAQ:VRTX) has since narrowed its focus and is now a biotechnology company known for its groundbreaking treatments for cystic fibrosis (CF), a genetic lung disease.
1. Shrinking Adjusted Operating Margin
Adjusted operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies because it excludes non-recurring expenses, interest on debt, and taxes.
Looking at the trend in its profitability, Vertex Pharmaceuticals’s adjusted operating margin decreased by 50 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its adjusted operating margin for the trailing 12 months was 6.3%.
2. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Vertex Pharmaceuticals, its EPS declined by 44% annually over the last five years while its revenue grew by 21.5%. This tells us the company became less profitable on a per-share basis as it expanded.
3. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Vertex Pharmaceuticals’s margin dropped by 55.4 percentage points over the last five years. If its declines continue, it could signal higher capital intensity and investment needs. Vertex Pharmaceuticals’s free cash flow margin for the trailing 12 months was negative 7.2%.
Final Judgment
Vertex Pharmaceuticals isn’t a terrible business, but it isn’t one of our picks. That said, the stock currently trades at 26.6× forward price-to-earnings (or $500.94 per share). This valuation tells us a lot of optimism is priced in - we think there are better stocks to buy right now. We’d suggest looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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