What Makes Investors Keep Buying Pharma Shares At High Prices?

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    In the last few years, a number of pharma companies in India have been issued import alert from the US FDA. What this means is that there is a ban on the company exporting products to the US.

     What Makes Investors Keep Buying Pharma Shares At High Prices?
    Despite this the share price dips initially and keeps rising and investors continue to chase pharma stocks at any and every cost.

    One of the most expensive pockets of investment today is the pharma space. Take a look at some of the price to earnings multiple of pharma shares in India. We have taken the EPS based on the Q4 2014-15 results and multiplied the same by four to arrive at the approximate full year EPS and then the price to earnings ratio.

    Name Price Face Value P/E
    Glenmark Pharma Rs 783 Re 1 45.52
    IPCA Labs Rs 629 Rs 2 48.5
    Wockhardt Rs 1800 Rs 5 15
    Sun Pharma Rs 1012 Re 1 65.2 (based on 2013-14 EPS)
    Lupin Labs Rs 2000 Rs 2 54
    Dr Reddy's Rs 3800 Rs 5 200
    Cipla Rs 711 Rs 2

    41.2

    Investors who have a fair understanding of fundamentals will agree that these price to earnings multiples or p/e multiples are certainly high.

    The Sensex P/E at the moment is just 17 times, which means one ends-up paying three to four times higher valuation for pharma companies. And probably ten times more for Dr Reddy's.

    Here are a few reasons why investors keep buying pharma shares, despite them being highly overvalued.

    a) Solid Growth Story

    Undoubtedly at a time when economic growth has not yet rebounded, the pharma story is intact in terms of growth. This is one reason why investors are ready to pay a heavy premium.

    b) Well Managed Companies

    Most of these companies are very well managed and have shown an inclination for takeovers, enhanced research capabilities etc. Investors are willing to pay a price for enterprising companies and managements.

    c) Very Few Quality Stocks Elsewhere

    The problem right now is that the markets are flush with funds from FIIs and domestic institutions. There are very few quality stocks elsewhere, so investors keep chasing quality stocks and drive-up their prices. This is happening with pharma stocks at the moment with pockets like metals, banking, infra not showing solid growth in earnings.

    At the moment the price of pharma stocks defies any sense of logic. If investors invest in these stocks now, they would be buying at ridiculously high levels. Expecting bumper returns from here on like in the past can be ruled out.

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