Every month, I scan the Russell 3000 for companies that meet my strict investment criteria. This index represents roughly 98% of all U.S. investable securities.
Over the past 24 months, my search typically yielded 10 to 20 names that could potentially make it on to my recommendation list.
My latest search yielded a whopping 126 stocks …
And all of them are trading below 12 times earnings. These companies are also projected to grow earnings more than 20% over the next 12 months.
To put this in perspective, the average company in the S&P 500 trades at 17 times earnings. Those names are growing earnings at less than 2% right now.
I’ve only seen valuations this good a few times in my 20-year-plus career. Two periods that come to mind are 2001 and 2009.
These times — which represented incredible buying opportunities — followed major market corrections. Both times, the U.S. economy was also in a recession.
Today, we are not in a recession.
Our banking system is stronger than ever … balance sheets are flush with cash … corporate profits are near record highs despite slowdowns in Europe and China … and interest rates are expected to stay near record-low levels at least over the next few years …
So why are valuations so compelling?
Investors are terrified to own stocks.
Most of this fear is driven by the media. The recent 1,000-point intra-day pullback in the Dow Jones index made front-page headlines around the world. It brought back fears of the credit crisis in 2008 — where most Americans watched their retirement accounts fall more than 30% in value.
The two major political parties are hosting debates in front of next year’s presidential election. This is a time when potential candidates tell us how broken America is — and how they think they can fix it.
Their quotes about our “uncontrollable” national debt, the weakening of middle-class Americans and how our country is one step away from another major terrorist attack make headline news on a daily basis.
They also get posted to hundreds of millions of people through social media.
This uncertainty is creating fear among investors.
But these fears of owning stocks are overblown …
In fact, the markets will likely keep trading higher to close out 2015.
Lucky for us, fear continues to be a major factor that’s driving some stocks lower.
In particular, drug companies have been going through some rough times.
Manufacturers like Pfizer (PFE), Merck (MRK), Sanofi (SNY) and GlaxoSmithKline (GSK) have made a living producing blockbuster drugs. These are drugs that produce over $1 billion in annual sales.
In fact, Bristol-Myers Squibb (BMY) generated over $6 billion in sales in 2010 from its heart-attack prevention drug called Plavix. Merck generated over $3 billion in annual sales from asthma treatment Advair. AstraZeneca (AZN) made over $5 billion in 2010 from Seroquel — used to treat schizophrenia.
Today, these drugs are no longer blockbusters.
You see, the patents on these signature drugs have expired. A patent grants a company the right to exclude competitors from selling their product for 20 years. Once a patent expires, it opens up the door to new competition.
Patent expiration has been headline news over the past few years. And most “Big Pharma” companies help reduce this risk by investing in (and acquiring) early stage biotech companies. Big Pharma also used their massive cash hoards to increase their dividends and buy back their stock.
However, the patent expiration trend is far from over.
According to research firm EvaluatePharma, $214 billion in worldwide drug sales are at risk over the next six years due to patent expiration.
This cash will flow directly into generic companies.
Generic drug companies are competitors to “Big Pharma.” Once brand-name drugs come off patent, generic companies are allowed — by law — to make nearly identical products. Since these blockbuster drugs have already been developed and marketed over their 20-year history, generic companies don’t have to incur these costs.
Some of my favorite names in the space include Mylan (MYL), Teva Pharmaceuticals (TEVA)and Perrigo (PRGO).
These stocks are down more than 20% from their highs. And most of the industry is consolidating.
For example, Teva pushed lower after announcing a takeover of Allergan’s (AGN) generic division in July. Mylan and Perrigo also sold-off as these well-established companies are trying to work out their own deal to become one of the largest generic companies in the world.
Mylan, Teva and Perrigo are in great position to take advantage of the potential $214 billion in sales that will be exposed to generic drugs over the next six years. I suggest buying these names on this pullback and holding long-term.