Time to Dive Into Zoetis

Drug Manufacturing company Zoetis is taking Wall Street by surprise today, falling to $131.04 and marking a -11.1% change compared to the S&P 500, which moved -0.4%. ZTS is -42.13% below its average analyst target price of $226.45, which implies there is more upside for the stock. As such, the average analyst rates it at buy. Over the last year, Zoetis has underperfomed the S&P 500 by -12.7%, moving -32.3%.

Zoetis Inc. discovers, develops, manufactures, and commercializes animal health medicines, vaccines, and diagnostic products in the United States and internationally. The company is categorized within the healthcare sector. The catalysts that drive valuations in this sector are complex. From demographics, regulations, scientific breakthroughs, to the emergence of new diseases, healthcare companies see their prices swing on the basis of a variety of factors.

Zoetis's trailing 12 month P/E ratio is 29.7, based on its trailing Eps of $4.41. The company has a forward P/E ratio of 23.5 according to its forward Eps of $5.57 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US healthcare companies is 13.21, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

To better understand ZTS’s valuation, we can divide its price to earnings ratio by its projected five-year growth rate, which gives us its price to earnings, or PEG ratio. Considering the P/E ratio in the context of growth is important, because many companies that are undervalued in terms of earnings are actually overvalued in terms of growth.

Zoetis’s PEG is 2.82, which indicates that the company is overvalued compared to its growth prospects. Bear in mind that PEG ratios have limits to their relevance, since they are based on future growth estimates that may not turn out as expected.

To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on ZTS's margins:

Date Reported Revenue ($) Cost of Revenue ($) Gross Margins (%) YoY Growth (%)
2021-12-31 7,776,000,000.0 2,295,000,000.0 70.49 1.47
2020-12-31 6,675,000,000.0 2,038,000,000.0 69.47 0.09
2019-12-31 6,260,000,000.0 1,915,000,000.0 69.41 3.09
2018-12-31 5,825,000,000.0 1,903,000,000.0 67.33 n/a
  • Average gross margin: 69.2 %
  • Average gross margin growth rate: 1.5 %
  • Coefficient of variability (higher numbers indicating more instability): 1.9 %

Zoetis's gross margins indicate that its underlying business is viable, and that the stock is potentially worthy for investment -- as opposed to speculative -- purposes.

To deepen our understanding of the company's finances, we should study the effect of its depreciation and capital expenditures on the company's bottom line. We can see the effect of these additional factors in Zoetis's free cash flow, which was $1,736,000,000.00 as of its most recent annual report.

Over the last 4 years, the company's average free cash flow has been $1,549,000,000.00 and they've been growing at an average rate of 7.0%. With such strong cash flows, the company can not only re-invest in its business, it can afford to offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in ZTS have received an annualized dividend yield of 0.8% on their capital.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts). Zoetis's P/B ratio is 13.4 -- in other words, the market value of the company exceeds its book value by a factor of more than 13, so the company's assets may be overvalued compared to the average P/B ratio of the Healthcare sector, which stands at 4.07 as of the third quarter of 2022.

Zoetis is likely fairly valued at today's prices because it has an inflated P/E ratio, an elevated P/B ratio, and a steady stream of strong cash flows with an upwards trend. The stock has mixed growth indicators because of its decent and consistent operating margins and an above average PEG ratio. We hope this preliminary analysis will encourage you to do your own research into ZTS's fundamental values -- especially their trends over the last few years, which provide the clearest picture of the company's valuation.

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The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.