DHR is overpriced despite its favorable market positioning

As an investor that prefers to focus on value, my preference is to emphasize stocks that are currently trading at significant discounts to their basic valuation metrics. That usually means that most of my attention is directed on stocks that are also trading at or near to yearly or historical lows. That also means that stocks you’ll find near the top of their yearly ranges almost always get passed over. That’s even more true if the stock has been following a multiyear upward trend.

Value investing is often at odds with one of the most basic principles of technical analysis, which suggests that stocks tend to follow the direction of their prevailing trends. That’s an idea that also makes intuitive, even emotional sense to most investors; a stock is more likely to go up if it has already been going up. It’s one of the reasons that I think most talking heads focus on stocks that have already shown impressive performance, or even better, that are pushing to a fresh, new set of all-time highs.

With the stock market sitting in bear market territory thanks to fears that COVID-19’s impact will be sharp enough, and extended enough to impact not only the global economy, but also to finally put the brakes on a U.S. economic growth cycle that has lasted more than a decade, market uncertainty has remained high for most of the past month and half. One of the sectors that has rebounded nicely in the last week or so is the Healthcare sector; as measured by the S&P 500 Healthcare Sector SPDR ETF (XLV), these stocks have rallied about 4.5% in the last week although on a year-to-date basis, the sector is still down about-17%.

This is a sector that includes a number of large cap stocks that have come into sharper focus over the last couple of weeks as the pressures on medical professionals and the entire sector to meet the challenge not only of COVID-19, but also of taking care of regular, day-to-day community needs. From a strictly objective point of view, that represents both a significant challenge, and an opportunity for companies in this sector that could make the strongest useful to work with as an investment in the near term. I’ve already highlighted a few stock this week that have come across my desk, and today I’m adding Danaher Corp. (DHR), one of the largest stocks in the Health Care Equipment and Supplies industries.

Fundamental and Value Profile

Danaher Corporation (Danaher) designs, manufactures and markets professional, medical, industrial and commercial products and services. The Company operates through four segments: Life Sciences, which offers a range of research tools that scientists use to study the basic building blocks of life, including genes, proteins, metabolites and cells, in order to understand the causes of disease, identify new therapies and test new drugs and vaccines; Diagnostics; which offers analytical instruments, reagents, consumables, software and services; Dental, which provides products that are used to diagnose, treat and prevent disease and ailments of the teeth, gums and supporting bone, and Environmental & Applied Solutions, which consists of various lines of business, including water quality and product identification. As of December 31, 2016, Danaher’s research and development, manufacturing, sales, distribution, service and administrative facilities were located in over 60 countries. DHR has a current market cap of $92.7 billion.

Earnings and Sales Growth: Over the last twelve months, earnings were flat, while sales declined by -9.23%. In the last quarter, earnings improved by a little more than 10% while Revenues dropped by about 3.35%. DHR’s Net Income versus Revenue is healthy and strengthening dramatically, running at 15% over the last twelve months and nearly 45% in the last quarter. DHR is a company that has historically increased earnings and revenue via a combination of organic and acquisition-driven growth. This week the company finalized one of its most ambitious acquisitions ever, with the purchase of GE Biopharma for $21.4 billion. The deal is generally seen as a positive because GE’s biotechnology business is one of DHR’s biggest competitors; however the sheer size of the deal means integration with the rest of its Life Sciences segment could be a challenge.

Free Cash Flow: DHR’s Free Cash Flow is healthy, at about $3.3 billion. That translates to a Free Cash Flow Yield of 3.6%.

Debt to Equity: DHR has a debt/equity ratio of .75, which is a good reflection of the company’s conservative approach to leverage. Their balance sheet shows about $19.9 billion in cash and liquid assets against $26.5 billion in long-term debt. Their balance sheet, including their strong Net Income profile indicates they have more than adequate operating profits to service their debt, with very healthy liquidity to cover any potential shortfall.

Dividend: DHR pays a modest annual dividend of $.72 per share, which at its current price translates to a dividend yield of about .56%.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $90 per share, which means that DHR is significantly overvalued, with more than -30% downside from its current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s downward trend from its peak near the end of January at about $170 per share. DHR rebounded from a multiyear low at around $120 about a week ago to touch the 38.2% Fibonacci retracement line at around $139 before dropping back in the last couple of days. It is now at about the mid point between the 38.2% Fib line and that recent pivot low, as market volatility is giving the stock big swings between high and low points right now. A push above $139 could give the stock room to rally to about $144 based on previous highs, and the 50% retracement line around that level, with additional room to $150, where the 61.8% line sits if bullish momentum persists. On the other hand, if the overall, bearish tone of the stock’s trend since January takes control again, it could test that low around $120, with additional downside to around $110 if that support doesn’t hold.

Near-term Keys: The stock’s fundamentals are very strong, but the truth is that the value proposition isn’t attractive at all. That means that if you are looking to make a long-term bet on DHR, right now it is based strictly on your expectations for the stock’s growth forecasts. The next quarter or two could change that perspective, as more data relative to the integration of GE’s Biopharma business is folded into the stock’s metrics. Until then, I think the smartest way to work with this stock is to use short-term trading methods. There is about $10 right now between the stock’s low around $120 and its current price, so if you see daily momentum on the bearish side, and you’re willing to be aggressive, you could think about shorting the stock or buying put options using $120 as a profit target. A higher probability signal on the bearish side would come from seeing the stock drop below $120, with room to about $110 in that case. On the other hand, if the stock can break above immediate resistance at $139 could be a useful signal to think about buying the stock or working with call options, using $144 as a near-term target price and $150 attainable if bullish momentum picks up.


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