Bet against Valeant? Get a second opinion

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Valeant Pharmaceuticals International Inc. is facing renewed scrutiny of its business model and performance metrics, this time from influential financial author Jim Grant.

But the company has a history of punishing any who dare to bet against it, a trend that could continue as investors latch on to one of Canada's few large-cap growth stocks.

Last week, Mr. Grant added himself to the ranks of the company's critics, calling Valeant a "financialized pharma company," more concerned with its "towering share price" than with research and development in the pharmaceutical sector.

Yet, investors have disregarded such criticism before, preferring to look instead at the company's track record under its ultra-ambitious chief executive officer Michael Pearson.

"This guy has credibility," said Brian Acker, president and CEO of Acker Finley Inc. "He's done what he said. So it's not surprising that the market now gives it a premium."

Valeant stock has doubled over the past year and has risen 25 per cent since January, when Mr. Pearson said Valeant would strive to be one of the top five pharmaceutical companies in the world by the end of 2016. That would require a tripling in size to around $150-billion (U.S.) in market cap.

Mr. Pearson has already achieved an "aspirational goal" set two years ago to become one of the 15 largest pharmaceutical firms in the world. He accomplished that through the relentless acquisition of other companies, including eye care firm Bausch & Lomb Inc., purchased last year for $8.7-billion.

"Investors have historically been rewarded for owning [specialty] pharma stocks in advance of their accretive deals, and we think this management team is still the best to play this business model," UBS analyst Marc Goodman said in a recent note, reiterating his $170 share price target.

"And based on our meetings with management, we think Valeant will execute on a significant deal in [the first half of this year]."

Of the 22 analysts covering the stock, only two have a "sell" recommendation, while the average target price sits at $161.50, representing a 15-per-cent premium on Wednesday's closing price in New York.

For Canadian investors, Valeant has represented one of a dwindling number of large-cap growth plays as the energy and mining sectors have fallen on a couple of hard years.

"There are not a lot of growth stories," said Larry Berman, co-founder of ETF Capital Management. "So it almost doesn't matter what the news is, the market loves it and it's got a lot of momentum."

Valeant's stock now trades at a forward price-to-earnings ratio of 16.3, which sits at the high end of the range also occupied by industry giants such as Pfizer Inc., Johnson & Johnson, and Merck & Co. Inc.

But unlike those pharma mainstays, Valeant hunts for its growth "in the stock market, not the laboratory," Mr. Grant said in the most recent instalment of his widely read Interest Rate Observer.

Valeant spends just 2.7 per cent of its sales on R&D, compared with 13.8 per cent of sales for those three peers, Mr. Grant said.

The company also emphasizes cash earnings per share, which excludes acquisition-related expenses and other one-time costs, and which Mr. Grant calls "a forgiving metric of its own creation."

And yet these criticisms have for years been levelled at Valeant, which has defied its skeptics with share price appreciation of 1,150 per cent over the past five years.

Still, Valeant's investors should remain vigilant for signs of a change in sentiment and may want to consider trimming their position as the stock appreciates, Mr. Berman said.

"Nothing doubles and triples over and over again. It works until it doesn't."