These 3 Stocks Look Expensive but Are Actually Cheap

Markets Motley Fool

A stock's price -- or even its current valuation -- rarely tell the whole story regarding its ability to produce respectable returns on capital over the long-term. In fact, deep value can be tremendously difficult to quantify in many cases -- leading to some stocks being incorrectly viewed as expensive based on short-term valuation metrics.

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Armed with this insight, we asked three of our investors which stocks with rich valuations they think might be attractive long-term buys. They suggested BioMarin Pharmaceutical (NASDAQ: BMRN)Activision Blizzard (NASDAQ: ATVI), and BlackRock (NYSE: BLK). Read on to find out more.

An undervalued gem 

George Budwell (BioMarin Pharmaceutical): Valuation metrics such as price to sales or price to earnings ratios can be extremely misleading when it comes to biotech stocks. The rare disease specialist BioMarin Pharmaceutical, for example, sports a stately price to sales ratio of 12 at the moment that might be rather off-putting for traditional value investors. The prevailing industry average, after all, tends to range from 3.5 to 4.0 under normal market conditions -- implying that BioMarin is indeed grossly overpriced relative to its peers. 

If we dig deeper into the biotech's value proposition, though, I think a far different picture emerges. BioMarin currently sports six approved products for a variety of rare conditions, and another four late-stage candidates with sky-high commercial potential. The company's late-stage treatment for achondroplasia (the most common form of dwarfism) dubbed vosoritide, for example, could easily generate blockbuster level sales if approved. In other words, the commercial potential of BioMarin's late-stage pipeline arguably isn't even reflected in its current valuation -- despite its relatively high price to sales ratio. 

As an added bonus, orphan drugs -- or drugs indicated for exceedingly small population sizes -- tend to come with extended periods of exclusivity and truncated development timelines. The net result is that BioMarin, and many of its orphan drugmaker peers, generally have substantially less leverage on their balance sheets, and are also able to overcome clinical setbacks far quicker than traditional biopharmas.

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BioMarin, for instance, has a debt to equity ratio of only 24.2, and the company has also averaged around five years to bring new experimental compounds to market. Putting these figures into context, it's fairly common for revenue-generating biopharmas to sport debt to equity ratios in excess of 70%, and most small molecule drugs take upwards of a decade to develop.

All things considered, BioMarin may look expensive based on standard valuation metrics, but the company is actually cheap when you factor in its strong late-stage pipeline, low debt levels, and ability to bring new drugs to market in an expedited fashion. 

Ready to level-up

Keith Noonan (Activision Blizzard): With its stock up more than 440% over the last five years and shares trading at roughly 30 times forward earnings estimates, it's not unreasonable to question whether Activision Blizzard is still a good buy at current prices. Yet, despite trading near all-time highs, I think the video game publisher still looks cheap and has the potential to deliver substantial returns for long-term investors. 

Much of Activision Blizzard's impressive capital appreciation in recent years is connected to the growth of full-game downloads and in-game content sales -- trends which appear to be on track to continue and create ongoing sales and earnings momentum. The company enjoys a leadership position in one of the biggest growth segments in entertainment, and its emerging businesses like e-sports, film production, and consumer products create avenues for explosive growth down the line.

Taking a closer look at its opportunity in e-sports, the company currently has four of the top-10-most-watched games on Amazon's Twitch streaming service, recently sold rights to the first seven teams in its Overwatch league for $20 million a piece, and has its own competitive organization and streaming platform with Major League Gaming. Research firm Newzoo estimates that e-sports revenue will grow from roughly $700 million in 2017 to $1.5 billion in 2020, and growth in gaming as a spectator sport should also have the effect of bringing new attention to Activision's games. 

Shifting gears, the company's push into consumer products looks to be a relatively low-risk, high-reward venture, and, if its film-production efforts prove successful, Activision will reap the rewards of being a true cross-medium powerhouse. So, while the publisher's stock might look expensive by some metrics, there's good reason to think its growth story is just getting started.

Profit from the ETF revolution

Dan Caplinger (BlackRock): At more than $400 per share, many would consider BlackRock stock to be expensive. By that standard, that's a fair assessment, as the investment management giant has one of the costliest share prices you'll find. Yet the $68 billion company has become a leader in managing people's money, and the rise of exchange-traded funds is largely responsible for BlackRock's success. As the company behind the popular iShares line of ETFs, BlackRock has reaped huge rewards from the move toward passive investing. Even the relatively modest percentages that BlackRock is able to collect from its funds through management fees are enough to generate a lot of revenue, and the suitability of ETFs as long-term investments makes most of those revenues recurring year after year.

BlackRock doesn't necessarily look at first glance like the perfect value stock, trading at nearly 17 times forward earnings estimates. Yet the thing you have to remember about BlackRock is that the ETF revolution shows few signs of stopping. Total ETF assets under management recently topped the $3 trillion mark, and iShares continues to draw more than its fair share of assets coming into the market. BlackRock's primary risk is a bear market that throws investor confidence for a loop, but until that happens, the manager's growth has the potential to carry its shares still higher in the future. 

10 stocks we like better than BlackRock
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Dan Caplinger has no position in any of the stocks mentioned. George Budwell has no position in any of the stocks mentioned. Keith Noonan owns shares of Activision Blizzard. The Motley Fool owns shares of and recommends Activision Blizzard and Amazon. The Motley Fool recommends BioMarin Pharmaceutical. The Motley Fool has a disclosure policy.