This morning was another great reminder of just how insane the market can be. Let’s say I told you a company doubled revenues and quadrupled earnings since the same period last year. What do you think would happen to the stock price after the earnings announcement?

  1. The stock price goes up because they crushed earnings
  2. The stock price goes down because numbers are rational and Wall Street is not

The answer is… 2! And yet again, I’m left very confused by other investors.

Gilead (GILD) is a pharmaceutical company that makes leading Hepatitis C and HIV drugs. The company released a new Hepatitis C drug last year, Solvadi, which turned into essentially a cash machine. I hold Gilead in my portfolio due to its leadership in the Hepatitis C and HIV markets, strong financial position, and extensive research & development pipeline.

Gilead reported earnings after the market closed last night and I was feeling cautiously optimistic. And like I expected, earnings were a blowout. Some notable stats:

  • Fourth-quarter net income was $3.49 billion, or $2.43 a share, vs. analyst estimates of $2.23 per share (and quadruple 2013’s fourth quarter net income)
  • Revenue was $7.31 billion, vs. analyst expectations of $6.72 billion (and over double last year’s $3.12 billion)
  • Announced that it will start paying a dividend of $1.72 per share, per year (great news for me, since I love dividend stocks!)
  • Announced a new $15 billion share buyback program that will be executed over the next five years

The price reaction to the earnings was also a blowout, but in the wrong direction. The stock is down about 8% since yesterday. So what happened!?

Gilead Earnings

Investors were partially spooked by management’s lower guidance for product sales next year. They estimated 2015 sales of $26-$27 billion, only 6-10% higher than 2014. But Gilead’s management tends to makes low-ball expectations (which are easier to beat), so that probably wasn’t a major driver of the price drop.

The main reason investors aren’t celebrating is fears of price decreases and increased competition. Late last year, AbbVie (ABBV) had a competing hepatitis C drug approved, which it’s selling at a lower price point. While Gilead’s drug is still the choice for many providers (and CVS), they will have to lower their price to compete. Based on management guidance last night, the discount on Gilead’s Solvadi drug is expected to jump to about 46% this year. And if the price drops without the number of sales increasing, that could mean lower revenues and net income.

While I’m slightly concerned about the price decrease, I think the fears are overblown. I think Gilead can make up for much of the price decrease with volume. Since Solvadi is so expensive (about $84,000 a year), insurers had been limiting treatment to just the sickest Hepatitis C patients. If Gilead drops its prices, insurers should allow a wider range of patients to use the drug. Not to mention, Gilead’s margins are so high already (a 50% profit margin last quarter), that it could lose some margin points on the top and still be extremely profitable.

Gilead Pipeline
The bull case: A small snapshot of Gilead’s pipeline (I don’t understand the words but the picture looks impressive)

Long-story short (pun intended), I’m maintaining my portfolio stake in Gilead. Since I believe in Gilead’s long term potential, I’m ok (well, I’m trying really hard to be ok) with some short term blips. I’m adding this morning’s events to the list of reasons I’m extremely happy that I’m focusing on long-term investing and not trading.

 

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