8 Stocks With Attractive Price/Sales Ratios

DRUG MAKERS GENERATE heaps of cash. The top 25 together clear a Bill Gates-size fortune every nine months. They stand to lose a worrisome amount of sales between 2010 and 2014 as a number of key patents expire. The prescription seems obvious: more research spending in a hurry, but also on the cheap, since looming sales declines will have to be made up for with cost cuts.

Indeed, the Food and Drug Administration reports a record number of new drugs under investigation after seven straight years of increases. But it has been picky of late on approvals, suggesting today's experimental compounds will need larger, longer and more complex trials, potentially straining drug makers' budgets.

These trends bode well for contract research organizations, or CROs, which perform drug trials for hire. Their sales pitch to drug makers promises faster trial completions at lower cost than in-house trials. Drug makers seem agreed; they now turn over about a quarter of research spending to contractors, and that figure is rising.

In June 2007 this column recommended shares of Kendle International (KNDL), a small CRO. Its stock has since climbed 8% — a modest return, but one that bested the broad market by 25 percentage points and America's big drug makers by far more. Kendle collects slightly more than half its sales outside the U.S. Its broad geography is helping win new jobs from global drug firms. A trial conducted in a number of countries at once leads to faster approvals for multiple markets, analysts say. Foreign trials are also often cheaper. Emerging-markets ones allow for smaller payments to lure patients and less regulation to start trials.

Kendle gets passing but not stellar marks in a fiscal check-up. Its small size exposes it to cancellations and delays and can result in lumpy quarterly numbers when upfront spending on a new trial far precedes the fees collected from it. Earnings in the company's most recent quarter missed Wall Street forecasts by 19%. That has helped send the stock 19% lower this year. Kendle has a full debt load and plenty of goodwill on its balance sheet waiting to be written off against earnings. Both result in part from a 2006 purchase of the late-stage trial operations of Charles Rivers Laboratories and a June purchase of DecisionLine, a Toronto early-stage specialist. Stockholders might now like to see a pause in purchases accompanied by organic sales growth, resulting in more free cash flow and debt repayment.

Still, the stock's current price of 21 times forecast 2008 earnings seems plenty reasonable, considering earnings are expected to climb 26% this year. Kendle turned up recently on a screen for companies whose share values seem modest relative to their sales. Its price/sales ratio of 1.0 makes for a discount of 30% to the S&P 500 median.

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Also See:
8 Small-Cap Stocks With Big Growth Potential
8 Stocks for Fans of Takeover Targets
8 Stocks for Finicky Value Investors

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