Valuation analysis for AmerisourceBergen Corp. (NYSE:ABC)

Some stocks are priced so richly in our current environment, but recent price action has investors so happy that they forget about monitoring valuation.  That is, however, exactly what must be done, and on an ongoing basis, to prevent unexpected losses.

ABC Amerisource EPS Earnings Growth

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AmerisourceBergen Corp. (NYSE:ABC) has certainly been doing something right.  EPS and Revenue has been growing solidly, we love to see parallel relationships like this, and the yearly growth rate is now 18.83% as of the last report.  Our evaluation of EPS growth excludes onetime events to focus on growth from operations, and then we compare trailing 12 month data accordingly to determine yearly growth.  We consider 18.83% to be a solid growth rate.

However, the stock has been surging, it was $25 at the end of 2010, and it is now $88.  Buying a stock that has run this much first warrants careful fundamental and technical considerations.  According to our review of valuation though, at least for now, ABC does not appear out of line.

Specifically, the PE multiple for ABC, although it has also increased significantly from late 2010 levels to now (from about 14x to about 24x), it has also done that while EPS growth has been solid, and that makes the multiple expansion seem appropriate.

ABC Amerisource PE Price Earnings Multiple

However, this is also where the risk lies.  Even though the current multiple of 24x earnings looks appropriate given its current growth rate, and therefore that makes ABC look fairly valued here, the company would need to maintain a growth rate like that to warrant the current multiple.  If the growth rate falls back to where it was at the beginning of 2013, closer to 5%, the stock could fall simply due to multiple contraction.

Technical take:

According to our real time trading report for ABC the stock is in the process of breaking out above longer term resistance as we have defined it, and that is a bullish sign.  We therefore would indeed be buyers of ABC at levels very close to former longer term resistance levels, which have since been converted into support, but then that converted support level will also act as our risk control and we would exit the trade if longer term support began to break.

Summary:

ABC looks fairly valued here but if the growth rate that currently exists declines back to early 2013 levels the stock will look rich.  Thus far that has not happened, and in addition the stock has broken above longer term resistance levels slightly, and that is great for two reasons.  First, if the stock maintains the breakout the buy signal that triggered will likely be rewarded nicely, but if the stock begins to falter the red flags that would then be associated with a reversal below longer term converted support can help protect investors from a period of multiple contraction that could follow. 

In other words, if ABC breaks below longer term converted support again we would recommend that investors sell the position and traders do the same because that may be a leading indicator that the current rate of growth may not be sustained.  Keep in mind, if the multiple simply contracted to where it was in late 2012 the stock could lose over 30% of its value without any material problems surfacing at the company.  That makes this a high risk play in our opinion and the company MUST maintain this growth rate for the stock to remain even remotely on par with fair valuation.  Currently it is doing everything right, but it will need to continue to fire on all cylinders to make current valuation hold.

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