Bannon, Murphy 1

Pfizer Financial Analysis

Riley Bannon

Dylan Murphy

Bannon, Murphy 2

Table of Contents

1. Executive Summary Page 3

2. Purpose of the Paper Page 4

3. Methodology Page 5

4. Economic Analysis Pages 6-7

5. Industry Forecast Pages 8-10

6. Pfizer’s Competition Pages 11-14

7. Analysis of Pfizer Pages 15-19

a. Pfizer’s Business Strategy

b. Pfizer’s Accounting Methods

c. Financial Analysis

d. Forecasts of Pfizer’s Future Financial Statements

e. Valuation of Pfizer’s Common Stock

8. Conclusions Page 20

9. Recommendations Page 21

10. Bibliography Pages 22-23

11. Appendix Pages 24-25

Bannon, Murphy 3

Executive Summary

As stated in this paper, we, Riley Bannon and Dylan Murphy, find that Pfizer is currently

streamlining its operations to increase profit margins and better compete in the pharmaceutical

industry. The firm faces a variety of challenges, including changes in currency exchange rates

and patent laws. We expect the company to conclude its streamlining processes and revert to

healthy growth in the next five years. The company employs somewhat little debt, preferring to

finance most of its activities through sales of equity, and its investors are rewarded through

dividend payouts. After carefully manipulating eVal, we conclude that Pfizer’s stock is

overvalued by less than $2 per share.

Bannon, Murphy 4

Purpose of the Paper

By consolidating this information, we attempt to gain a comprehensive understanding of

Pfizer and the industry in which it operates. We will understand how firms in the pharmaceutical

industry operate today and how the global economy affects their business structures. This paper

should guide potential investors who seek to make an investment decision in the pharmaceutical

industry by revealing the underlying causes and trends that are hidden within Pfizer’s financial

statements. The depth and breadth of our financial analysis ensures that we can provide investors

with the most complete and conclusive information. With the data that we assemble, we will

create a projection for the value of Pfizer’s stock. We will then make a recommendation to

potential investors to buy, sell, or hold Pfizer stock by comparing our calculated intrinsic value

to the current market value.

Bannon, Murphy 5

Methodology

We primarily used library research to gather information on the economy, the industry,

Pfizer, and its competitors. From the library database, we accessed information from First

Research, Hoover’s, and Value Line. We also visited the Financial Information page of the

websites of our company and its competitors in order to access their government records. When

analyzing financial data, we frequently used vertical and horizontal analysis of each firm’s recent

statements to understand trends and predict future outcomes. Our analysis of the statement of

cash flows allowed us to determine the true nature of each firm’s business structure by

examining the movement of cash.

Bannon, Murphy 6

Economic Analysis

Before analyzing Pfizer specifically, we will analyze the overall economy and provide an

economic forecast for the next few years (2015 to 2018). To do this, we will examine three

professional forecasts for several economic indicators, including gross domestic product (GDP),

the unemployment rate, interest rates, and inflation. For GDP, the Congressional Budget Office

(CBO) forecasts 2.9 percent growth in 2015 and 2016, and 2.5 percent growth in 2017 (Angres et

al, 30). Another GDP forecast from Kiplinger is somewhat more optimistic, with a projection of

3.3 percent growth in 2015 and continued expansion into 2016 (Babb et al, n. pag.). A third

outlook from Indiana Business Review is in the middle, with a forecast of 3 percent GDP growth

in 2015 (Witte, 4). For the unemployment rate, the CBO expects job gains of 180,000 per month

in 2015 and 130,000 per month in 2016 and 2017; and the CBO predicts that the unemployment

rate will drop to 5.5 percent by the end of 2015 and 5.3 percent by the end of 2017 (Angres et al,

30). Kiplinger’s unemployment outlook is somewhat more bullish, with a projection of job gains

of 250,000 per month in 2015 and an unemployment rate of 5.3 percent by the end of 2015

(Babb et al, n. pag.). The Indiana Business Review outlook is also more optimistic, with a

forecast of job gains of 220,000 per month in 2015 and an unemployment rate below 5.5 percent

by the end of 2015 (Witte, 5). For interest rates, the CBO projects three-month Treasury bill rates

of 0.2 percent in 2015, with an increase to 3.5 percent by 2018, and ten-year Treasury note rates

of 2.8 percent in 2015, with an increase to 4.4 percent by 2018 (Angres et al, 30). Kiplinger

predicts a slower rise in interest rates; the Kiplinger outlook projects that at the end of 2015, the

federal funds rate will be 0.75 percent and the bank prime rate will be 4 percent (Babb et al, n.

pag.). Indiana Business Review predicts a gradual rise in short-term interest rates from near 0

percent to near 1 percent by the end of 2015 (Witte, 5). For inflation, the CBO predicts an overall

Bannon, Murphy 7

inflation rate of 1.4 percent in 2015 and 1.9 percent in 2016, with stabilization at 2.0 percent in

2017 and beyond (Angres et al, 30). Kiplinger’s outlook is similar, with a projection of a 1.5

percent inflation rate in 2015 and higher inflation starting in 2016 (Babb et al, n. pag.).

Based on these economic outlooks, we have developed our economic forecast of GDP

growth, the unemployment rate, interest rates, and inflation. For GDP, we project 2.8 percent

growth in 2015, and we expect GDP growth to remain near 2.8 percent in 2016 through 2018.

We make this projection primarily because of factors that can both boost and inhibit GDP

growth. Factors that will promote GDP growth include: higher consumer spending, which makes

up a large portion of GDP; lower oil prices, which may help boost consumer spending; a

recovery in the housing market; and a tightening labor market, which indicates a strengthening

economy and higher wages (Angres et al, Babb et al, Witte, n. pag.). However, other factors may

keep GDP growth in check. These factors include: the relatively strong U.S. dollar, which may

inhibit sales in other countries and thereby reduce exports; and slow economic growth abroad,

which will also reduce exports (Angres et al, Babb et al, Witte, n. pag.). For the unemployment

rate, we expect a slight downward trend, similar to what the CBO projects; we expect the

unemployment rate to decrease from 5.5 percent at the end of 2015 to 5.3 percent at the end of

2017. We expect the tightening labor market and increases in consumer spending to contribute to

this decrease in the unemployment rate. In addition, we forecast a gradual increase in interest

rates. We expect the Federal Reserve to hold off on increasing short-term rates until perhaps

sometime in 2016, primarily because other countries currently have weak economies. This has

led to a strong U.S. dollar, which has kept interest rates in check. For inflation, we project a

gradual increase from 1.5 percent in 2015 to near 2 percent by 2017 because the strong U.S.

dollar and weak economies abroad will keep inflation increases in check.

Bannon, Murphy 8

Industry Forecast

Like companies in any industry, Pfizer faces unique challenges. The company indicates

in its Form 10-K that its primary industry is Pharmaceutical Manufacturing (SIC 2834). The

pharmaceutical industry is a highly competitive industry within the United States and around the

world. In this industry, companies face strict regulations and competition from a variety of

directions. A large component of the modern pharmaceutical industry is the race for mergers and

acquisitions as many large firms seek to absorb the positive traits of smaller or underachieving

companies. Pfizer’s place in the industry, and in the economy as a whole, becomes clearer as we

fully analyze the industry (“Pharmaceutical Manufacturing”, n. pag.).

Over the next four years (2015-2018), we expect the pharmaceutical industry to continue

to have strong numbers, although companies may experience tempered growth. The primary

reason that pharmaceuticals will continue to succeed is because of demand, particularly from

senior citizens. Seniors typically need more medications as they get older, and they accumulate

the majority of their medical bills in the final years of life. Senior citizens also remain a

significant portion of national and global demographics, partially due to increases in life

expectancy. We have no reason to expect that seniors will need fewer medications over the next

five years. Aside from sales to senior citizens, pharmaceuticals should continue to see sales

growth among all consumer demographics because the drug industry features inelastic demand.

This means consumers need medications regardless of the amount of spending money they have.

Because of this inelasticity, sales should rarely deviate from the norm.

As should be expected, our projections do not necessarily indicate significant growth in

this industry. We projected GDP to continue to grow at its current rate in our Economic Forecast,

but we expect this to have little effect on the industry due to inelastic demand. Similarly,

Bannon, Murphy 9

improvements in the labor market and in consumer spending will not significantly affect the drug

industry (Angres et al, Babb et al, Witte, n. pag.). While these economic factors would have an

effect on leisure goods, like vehicles, vacations, or other recreation, pharmaceuticals will remain

in demand regardless of the economic outlook. However, government regulation could have a

negative impact on the pharmaceutical industry. Some pharmaceutical firms consider regulation

a serious threat to business operations (“Novartis AG SWOT Analysis”, 9-10). Regulations could

restrict the selling price of drugs or modify the amount of financial aid given to needy

individuals. We believe that it is difficult to create expectations around future government

regulations, but the regulatory environment is still an important factor for investors to consider

because of its potential impact on the long-term relevancy of the pharmaceutical industry.

For companies in any industry, sales are crucial to their success. In the pharmaceutical

industry, firms distribute drugs to medical professionals, including doctors and pharmacists, and

the drugs are then supplied to patients. However, most advertising is directed toward the patients

because they can request a specific medication from their health care professional. This

marketing technique is especially common in the United States because the U.S. health care

system is more market-based than that of any other developed country; thus, patient marketing is

less relevant to companies that are primarily focused on international sales. Financial statements

indicate that most expenses come from marketing and research and development (R&D)

activities, while a relatively minor amount relates to the actual manufacturing of goods because

the individual pill can be made at a low cost. Therefore, the price of the drug is largely

determined by the demand in the marketplace and the sunk costs of marketing and R&D. In

addition to focusing on sales of drugs, pharmaceutical firms also have to contend with

competition from generic drug companies. Generic drugs are a significant concern for many

Bannon, Murphy 10

pharmaceutical companies with brand-name products because generic drug firms can undercut

the prices of these products. Furthermore, pharmaceutical firms like Pfizer face competition from

companies around the world. We observed this as we learned that some of Pfizer’s primary

competitors have headquarters in Europe. This is a significant factor because differences in tax

laws and currency exchange rates affect each pharmaceutical company differently. All of these

factors define the competitive landscape that exists in the pharmaceutical industry for firms like

Pfizer and major competitors (“Pharmaceutical Manufacturing”, n. pag.).

Porter’s five forces indicate that competition is fierce in the pharmaceutical industry.

Rivalry occurs because there are a limited number of wealthy companies in the industry. This

oligopoly creates significant competition between the major players in the industry. Threat of

new entrants is minute because the cost of entry is very high; education, technology, and

overhead severely limit the number of new firms capable of entering the market. Availability of

substitute goods can vary. Many pharmaceutical firms attempt to create medications for illnesses

that have not already been cured, so there are no substitutes for those drugs. On the other hand,

there are many drugs that have intense competition, like weight-loss drugs or hormone-changing

drugs. Bargaining power with suppliers is relatively high for pharmaceutical firms because these

firms do not need many products to manufacture drugs. Pharmaceutical companies also have

bargaining power with customers because there is an oligopoly in this industry, which gives the

firms a lot of power over potential buyers to dictate the cost of the good. For all of these reasons,

competition is particularly difficult in the pharmaceutical industry.

Bannon, Murphy 11

Pfizer’s Competition

Pfizer has several major competitors, including Merck, Novartis, and Sanofi. According

to its Form 10-K, U.S.-based Merck produces pharmaceuticals for humans and animals (Merck

and Co., Inc. 2013 Form 10-K, 1). Merck is a company that investors should watch carefully, as

indicated by its 2014 financial information. In 2014, Merck had the lowest sales ($42.2 billion)

and lowest gross profit margin (60.3 percent) among the four companies. (“Pfizer Competitive

Landscape”, n. pag.). However, Merck’s 2014 return on equity (ROE) of 24.2 percent is the

highest by a significant margin, and the company has a relatively high level of debt, with a debt-

to-equity (D/E) ratio of 0.44 (“Pfizer Competitive Landscape”, n. pag.). Merck’s 2013 statement

of cash flows provides further indication of high debt levels. In 2013, Merck added $2 billion to

its high amount of debt and sold $4 billion in treasury stock (Merck and Co., Inc. 2013 Form 10-

K, 77). Merck also issued $5 billion in equity (Merck and Co., Inc. 2013 Form 10-K, 77). The

company is in the process of acquiring multiple competitors, which could explain its recent debt

activities (“Merck and Co., Inc. SWOT Analysis”, 7). The acquisitions could help Merck

accelerate sales growth by offering new product lines, so investors should watch future financial

statements.

Despite its relatively sluggish financial performance, Merck does have several strengths

and opportunities, along with some important weaknesses and threats that the company needs to

address. Its strengths include good management, a strong R&D team, and a line of successful

products; however, the company has had to settle lawsuits associated with a faulty drug, and it is

no longer the only market leader (“Merck and Co., Inc. SWOT Analysis”, 4-6). Some

opportunities include Food and Drug Administration (FDA) approval of a large number of the

drugs that Merck has developed, and Merck’s ongoing acquisition of Cubist Pharmaceuticals and

Bannon, Murphy 12

Idenix Pharmaceuticals (“Merck and Co., Inc. SWOT Analysis”, 7-8). These are horizontal

mergers that will allow Merck to expand its product line. Some threats include competition from

generic drugs and U.S. health care reform, which requires Medicaid rebates and may reduce

Merck’s revenue (“Merck and Co., Inc. SWOT Analysis”, 9).

Another of Pfizer’s major competitors is Novartis, a company based in Switzerland. This

company, according to its Form 20-F, creates pharmaceuticals, over-the-counter drugs, vaccines,

and innovative medicines; its focus is on acquiring patents on innovative drugs, selling generic

pharmaceuticals, and performing corporate activities (Novartis AG Form 20-K, 27-28).

Financially, Novartis is one of the best performing companies in the industry. Its 2014 financial

information shows sales of $53.6 billion, which is the highest among the four companies (“Pfizer

Competitive Landscape”, n. pag.). Novartis has generated a return on assets (ROA) of 8.1

percent, and its ROE is 14.1 percent; its ROA and ROE are high relative to all the other firms

except Merck. Novartis has the second highest gross profit margin (67.7 percent) and price-to-

earnings (P/E) ratio (22.01) (“Pfizer Competitive Landscape”, n. pag.). Novartis has a relatively

low level of debt as well, with a D/E ratio of 0.29 (“Pfizer Competitive Landscape”, n. pag.). The

company’s 2013 statement of cash flows suggests that the company is financially stable. In 2013,

it had $13 billion in cash flows from operating activities, -$3 billion in cash flows from investing

activities, and -$9 billion in cash flows from financing activities; and these cash flows have

remained fairly consistent in recent years (Novartis AG 2013 Form 20-K, F-8).

Additionally, Novartis has several strengths and opportunities, but it also has some

important weaknesses and threats to address. The company’s strengths include a very diverse

health care portfolio that generates consistent growth, a strong R&D department, and robust

market performance (“Novartis AG SWOT Analysis”, 5-6). However, manufacturing problems

Bannon, Murphy 13

have developed due to FDA citations (“Novartis AG SWOT Analysis”, 6-7). Novartis has three

major opportunities that can generate future growth. First, the company has acquired one of its

competitors, GlaxoSmithKline, which will allow Novartis to expand its product line; second,

Novartis is divesting its non-core businesses, which will allow the company to focus on its core

portfolio; and third, increased global health care spending in emerging markets will provide an

opportunity for future growth (“Novartis AG SWOT Analysis”, 7-8). However, Novartis has

three important threats to address: competition from generic drugs, increased health care

regulations, and efforts in Europe to cut health care costs (“Novartis AG SWOT Analysis”, 9-

10).

A third company that competes with Pfizer is a French company called Sanofi. According

to its Form 20-F, Sanofi has a diverse growth platform, including emerging markets, vaccines,

animal health, and diabetes solutions. Sanofi heavily emphasizes innovation and seeks growth

opportunities (Sanofi 2013 Form 20-K, 20). Financially, Sanofi is among the worst performing

firms in the industry. Sanofi’s 2014 financial information shows sales of $41.5 billion – lowest

among the four companies – and gross profit margin of 67.7 percent – second lowest (“Pfizer

Competitive Landscape”, n. pag.). The firm is among the lowest in ROE (9.4 percent), ROA (5.5

percent), and P/E ratio (11.23) (“Pfizer Competitive Landscape”, n. pag.). However, it has a

somewhat low level of debt, with a D/E ratio of 0.32; this might be because it has recently

unloaded a substantial amount of debt, as indicated in its 2013 statement of cash flows (Sanofi

2013 Form 20-K, F-10). The statement of cash flows also shows that the company is steadily

losing cash in operating activities, but cash flows from financing activities have remained

relatively steady (Sanofi 2013 Form 20-K, F-10).

Bannon, Murphy 14

Though Sanofi is somewhat sluggish financially, it does have some strengths and

opportunities, along with weaknesses and threats that need to be addressed. Sanofi’s strengths

include its dominant share in the disease therapy, diabetes, and global vaccine markets, and its

ability to locate and prioritize untapped markets (“Sanofi SWOT Analysis”, 4-6). Its weaknesses

include loss of market exclusivity, which is affecting sales growth, and a developmental setback

for one of its drugs (“Sanofi SWOT Analysis”, 6-7). Sanofi also has opportunities for future

growth, including its increasing focus on emerging markets and its acquisition of bio-surgery

firm Pluromed, which will allow Sanofi to expand its product line (“Sanofi SWOT Analysis”, 7).

However, the company must address important threats, including drug cost control measures in

Europe, U.S. health care reform, and the possibility that one of its drugs will cause cancer

(“Sanofi SWOT Analysis”, 8).

Bannon, Murphy 15

Analysis of Pfizer

Pfizer’s primary source of revenue comes from the sale of health care goods produced

internally. Its product line includes medicines and vaccines, as well as what the 10-K refers to as

“consumer healthcare products” (Pfizer, Inc. 2013 Form 10-K, 1). It appears that these consumer

health care products occupy a small portion of Pfizer’s product line; we speculate that this

category could include over-the-counter supplies, like bandages or braces. Like many firms in

the pharmaceutical industry, Pfizer’s strategy for success includes relying on cutting-edge

innovation as its primary competitive advantage. In order to distinguish itself from its

competitors, the company specializes in drugs that can be provided primarily by specialists,

rather than general practitioners. Although a heavy reliance on R&D makes any health care firm

a risk for failure, Pfizer’s continued success in the industry serves as a precursor of future

successes. Additionally, Pfizer’s cash available for investment in R&D decreases the amount of

risk associated with heavy reliance on R&D. As was discussed previously in this paper (see page

11), Porter’s five forces indicate that Pfizer functions in an industry that features competition

among established firms, but limits the opportunity for new firms to enter the market. According

to eVal, Pfizer’s ROE is significantly greater than its net borrowing cost; in 2013, ROE was 27.9

percent and growing, while net borrowing cost was 2.1 percent. Not only is Pfizer making a

return to cover its debt, but its returns greatly exceed its borrowings. This indicates that the

company is highly efficient with the funds it has borrowed.

The firm’s financial statements reveal the current condition of the business. We noticed

that sales, cost of goods sold, inventory, and payables and receivables have all declined from

2010 to 2013. This seems to indicate to us that the company is selling fewer products. On the

other hand, net income has increased substantially over the same period, rising from $8.6 billion

Bannon, Murphy 16

in 2009 to $22 billion in 2013. It is unusual that net income continues to rise while the balance

sheet indicates that sales are falling. One cause for this trend is the discontinued operations

account, which has more than doubled each year from 2011 to 2013. We theorize that Pfizer may

be streamlining its operations, so that it continues to develop and sell only the most successful

products. Declining cost of goods sold indicates that Pfizer has responded to the reduction of

sales by cutting back on costs. After deliberating on all of these factors, we would predict that

Pfizer would sustain a high level of net income, although there is also risk associated with

offering fewer products. There is one section of the income statement that seems to conflict with

Pfizer’s business strategy. We observed that for Pfizer, R&D expenses, which are crucial for

pharmaceutical firms, still amount to only half of selling, general, and administrative (SG&A)

expenses. One reason for this discrepancy is that SG&A expenses include expenses for

marketing, which is a significant element in the business strategies of all pharmaceutical firms.

However, we would expect that Pfizer may consider reducing corporate costs that are included in

SG&A, so that the company can function more efficiently in future periods.

Ratio analysis tends to indicate that Pfizer is either ahead of or equal to its major

competitors in most categories. Pfizer is at the top of the industry in each of the following ratios:

gross profit margin (80.7 percent), inventory turnover (8.39 times per year), and current ratio

(2.67). In several other ratios, Pfizer is among the top companies; these ratios include net profit

margin (18.4 percent), ROE (12.4 percent), and P/E ratio (21.63). However, Pfizer has the lowest

ROA (5.4 percent) among its major competitors; this may indicate that Pfizer has new assets that

have not depreciated significantly in value, or the company may operate with more property and

equipment than its competitors. Furthermore, Pfizer has the highest D/E ratio (0.51), which

indicates that Pfizer borrows more cash than its competitors (“Pfizer, Inc. Competitive

Bannon, Murphy 17

Landscape”, n. pag.). Based on the ratios available, it appears that Pfizer’s greatest competition,

in terms of profitability, comes from Merck, which leads the competition in net profit margin

(28.2 percent), ROE (24.2 percent), and ROA (11.7 percent). In addition, according to the

statement of cash flows in eVal, Pfizer is a mature company that no longer prioritizes growth.

Pfizer’s statement of cash flows allows us to profile the company apart from its competition.

There is a significant inflow of cash from operating activities; cash flows from operating

activities have quadrupled from 2009 to 2013. Cash flows from investing activities are near zero,

and cash flows from financing activities are negative, mostly due to dividend payouts to common

equity holders. Moreover, though Pfizer has a high D/E ratio compared to its competitors, the

company has incurred less debt in each year of the period. Based on Pfizer’s position in its

industry and on the recent trends in its cash flow statements, we would consider Pfizer a healthy

and mature company that will provide a high dividend yield and minimal stock growth to

investors.

Forecasting is at the heart of the equity analysis process. The most important variable in

forecasting is sales growth. Several factors could have either positive or negative effects on

Pfizer’s future sales. Sales might improve due to the company’s recent patents and acquisitions,

as well as expansion into developing global markets. On the other hand, Pfizer’s sales could be

limited by discontinued operations, generic competition, currency exchange rates, and

government regulations. Aside from discontinued operations, all of these factors are predictable

in the pharmaceutical industry and are not expected to have a significant impact on sales growth.

However, discontinued operations will likely continue to create negative sales growth over the

next several years until Pfizer has streamlined its business operations. We project that Pfizer will

eventually revert to sales growth that is nearly equal to GDP growth, so that the company grows

Bannon, Murphy 18

at roughly the same rate as the economy. Although this process may take more than five years,

we have condensed our forecast so that we can make a reasonable five-year projection. We

project that sales will increase from -3.0 percent in 2014 to 2.8 percent in the terminal year

(2018). Value Line’s projection is similar to ours; Value Line forecasts sales growth of

approximately -6 percent from 2014 to 2015, followed by 1 percent growth from 2015 to 2016

(Pfizer, Inc. Value Line, 1). We project R&D and SG&A to remain relatively constant because

both of these expenses are critical to revenues at Pfizer. Due to streamlining, we have reduced

R&D from 12.2 percent of sales to 10.3 percent of sales over the forecasting period, and we have

reduced SG&A from 27.1 percent of sales to 25.7 percent of sales over that period. Discontinued

operations should decrease gradually over the forecasting period, as Pfizer ends its streamlining

process. We expect discontinued operations relative to sales to quickly decline from 10.3 percent

to zero over a three-year period. Dividends will likely remain steady because Pfizer is a mature

company, and because we expect Pfizer’s sales to gradually improve; thus, we forecast preferred

dividends to remain at $2 million per year. We expect ending operating cash relative to sales to

decline because we anticipate a slowdown in acquisitions and streamlining. Thus, Pfizer will not

need as much cash, and we project this ratio to decline from 54 percent to 35 percent over the

five-year period.

After comprehensive analysis of Pfizer and adjustment to eVal, we can estimate the

firm’s intrinsic value and compare it to the firm’s market value. As of May 8, 2015, our

estimated intrinsic value is $32.12 per share, while Pfizer’s market value is $33.58 per share

(Yahoo Finance, n. pag.). Our estimate is less than $2 below the market value. There are several

reasons why our valuation is below the market valuation. While our estimates for sales growth,

the D/E ratio, the amount of cash on hand, and other items are reasonable, they are probably not

Bannon, Murphy 19

the same as analysts’ estimates. Further, eVal’s computation for retained earnings appears flawed

and negatively impacts the paid-in capital account. There were also several forecasts for which

we were unable to make reasonable assumptions, like Ending Inventories / Cost of Goods Sold,

Ending Accounts Payable / Cost of Goods Sold, and Ending Net Property, Plant, and

Equipment / Sales. A professional forecaster may have been able to create an assumption more

reasonable than the one provided by eVal. After conducting a sensitivity analysis, we found that

Pfizer’s stock is highly sensitive to cost of equity capital; even a small change in cost of equity

capital results in a significant change in stock value. We found an inverse relationship between

cost of equity capital and Pfizer’s stock value. On the other hand, Pfizer’s stock is very

insensitive to changes in operating cash, current debt relative to total assets, cost of goods sold,

and sales growth for the first forecast year. We were able to make significant changes to these

variables without seeing large changes in Pfizer’s stock price. We have provided more details

regarding this analysis in the Appendix. Furthermore, we found that adjusting the date of

valuation by one year results in a change in Pfizer’s stock value of only 10 percent. Thus, we can

conclude that Pfizer’s equity is most sensitive to changes in cost of equity capital. This means

that a change in beta or the risk-free rate could have serious impacts on Pfizer’s shareholders.

We suspect that over the next several years, the risk-free rate will remain at a low level, which

would allow Pfizer’s stock value to stay at its current level. However, if the domestic economy

becomes healthier in the future, the risk-free rate may rise, which would cause Pfizer’s stock to

fall in value.

Bannon, Murphy 20

Conclusions

Our research determined that Pfizer is a mature company that pays out healthy dividends

to investors, and it is among the top performers in its industry. Pfizer is currently engaged in a

streamlining process, which has reduced revenues but has allowed the company to become more

efficient. We expect this process to end within the next two to three years. The company finances

its investing activities primarily through equity distributions, as it has taken on less debt in recent

years. Based on our projections, the company’s intrinsic value is less than $2 below its market

value.

Bannon, Murphy 21

Recommendations

Despite our faith in Pfizer’s long-term prospects, our forecasting leads us to suggest that

the investor should short the stock. That being said, the company’s high dividends make the

stock worth considering. In the event that an investor is confident in Pfizer, the company’s high

dividend yields would make its stock a wise long-term investment.

Bannon, Murphy 22

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Bannon, Murphy 24

Appendix

Cost of Equity

Capital Asset Pricing Model (CAPM):

Cost of equity = Risk-free rate* + Beta** × (Expected market return*** – Risk-free rate)

Cost of equity = 0.0192 + 0.83 (0.1228 - 0.0192) = 0.1052 or 10.52%

* Data collected from ycharts.com 4/23/15

** Data collected on Yahoo Finance 4/23/15

*** (2,117.49 / 1,186.69) ^ (1 / 5) – 1

*** Data collected on Yahoo Finance 4/23/15

Cost of Debt

Cost of debt = Average interest expense / Average total debt

Cost of debt = $957,130,000 / $33,227,018,000 = 0.0288 or 2.88%

Cost of Preferred Stock

Cost of preferred stock = Preferred dividends / Preferred stock

Cost of preferred stock = $2,000,000 / $33,000,000 = 0.0606 or 6.06%

Cost of Minority Interests

Cost of minority interests = Average minority interests / Average total assets

Cost of minority interests = $35,200,000 / $409,200,000 = 0.0860 or 8.60%