On August 8, 2023, the stock of the Danish pharmaceutical company, Novo Nordisk, rose by a remarkable 18% in a single day, a rare occurrence for a giant company with a market value of over 350 billion euros. Why has Novo Nordisk become the largest investment in the Sifter Fund?
On August 8, 2023, Novo Nordisk announced that its obesity treatment drug, Wegovy, reduced the risk of serious cardiovascular events, such as heart attacks, by 20% compared to the placebo group in the SELECT study.
This news caused Novo Nordisk’s stock to rise sharply by 18% in a single day.
The Sifter Fund invested in Novo Nordisk in December 2020. Nearly three years later, in August 2023, the stock’s weight is 9% of the entire Sifter Fund’s portfolio, surpassing even Microsoft, which is one of our longest-standing investments.
Several positive developments have occurred in Novo Nordisk’s business over the past three years, and the company’s stock price has offered nearly a 200% increase in euros (from 12/2020 to 8/2023) to Sifter’s investors, dividends excluded.
Novo Nordisk – Why did we invest in the company in 2020?
During the COVID-19 pandemic, Sifter’s research team conducted an intensive analysis of Novo Nordisk. We have often been careful of investing in pharmaceutical companies, as assessing their product portfolios can be complex. However, Novo Nordisk stood out due to its focused business strategy.
Novo’s operations are clearly focused around diabetes medications, and the company has an impressive history of innovation in diabetes treatment and money making power.
At the time of investment, Novo’s valuation was high, but quality companies are rarely available at a discount. Our conservative calculations were based on a modest 5-7% annual growth in the company’s core business. We also considered the potential of the company’s new obesity treatment drug Wegovy, but did not assign significant weight to this new growth business in our calculations, as the obesity treatment drug was not yet on the market.
Novo Nordisk’s business is of exceptional quality, and this is reflected in its key figures
The company’s revenue has grown at an average rate of 10% over the last five years and has accelerated in recent years. Correspondingly, the company’s net income has been increasing at an average rate of 8% per year.
| 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023E | |
| Revenue (M€) | 15 015 | 15 004 | 16 343 | 17 030 | 18 932 | 23 786 | 30 058* |
| Annual growth | -0,1 % | 8,9 % | 4,2 % | 11,2 % | 25,6 % | ||
| Net income (M€) | 5 126 | 5 183 | 5 217 | 5 653 | 6 422 | 7 464 | 10 684* |
| Annual growth | 1,1 % | 0,7 % | 8,4 % | 13,6 % | 16,2 % | ||
| Gross margin | 84,2 % | 83,5 % | 83,5 % | 83,2 % | 83,9 % | ||
| Net margin | 34,5 % | 31,9 % | 33,2 % | 33,9 % | 31,4 % | ||
| ROIC | 116,7 % | 98,0 % | 82,8 % | 69,0 % | 73,6 % |
Novo Nordisk’s business is protected by high barriers to entry
Novo operates in the tightly regulated pharmaceutical industry, which brings its own challenges. However, overcoming these challenges also strengthens the company’s moats, or means of preventing competitors from entering the same highly profitable markets.
High Research and Development (R&D) Investments
Developing a new drug is a complex and expensive process that requires significant investments in research and development. Novo Nordisk has heavily invested in its R&D operations, giving it a competitive edge in the development of new drugs, as has been the case with semaglutide.
Patents and Intellectual Property Rights
Once a new drug is developed, pharmaceutical companies secure patents to protect their intellectual property rights. These patents prevent competitors from producing and selling generic versions of the drug for a certain period, providing a temporary monopoly and extremely high margins. Semaglutide is protected until 2033.
Regulatory Barriers
Getting a new drug approved by regulatory authorities, such as the United States FDA or the European Medicines Agency (EMA), is a complex process that requires both resources and time. Developing a new drug and bringing it to market can take up to 12-15 years.
In retrospect, Novo’s stock was a bargain at purchase
Novo’s valuation is high, and it has always been so. Over the last five years, the P/E ratio has ranged between 25 and 50. In December 2020, we invested in the company even though its P/E was 25, and the company was relatively expensive for Sifter’s portfolio.
Instead of using the P/E ratio, we calculated Novo’s earnings yield five years into the future, which, in our opinion, provided a better forecast of the company’s true value. Based on our long term estimates, we decided to invest in the company.
Novo’s business growth has been stellar, and the company’s high buy price has proven to be bargain.
The corrected sentence is: “In our experience, extremely high-quality companies tend to improve their performance more than short-term valuation levels suggest, but Novo’s performance has been one of its kind.
Distinguishing stock price from business value
One of the cornerstones of Sifter’s investment strategy is to distinguish between the price of a stock and the value of the company. The price is what you pay, and the value is what you get.
It is common sense to buy a company’s shares if the projected value of its money making power, even with modest growth expectations, is greater than the price of its shares at the time of purchase.
At Sifter, we believe that within 3-5 years, the market will recognise the true value of the company, and the stock price will adjust accordingly. This is what happened in the case of Novo Nordisk.
No tree grows to the sky – Is Novo Nordisk now too expensive for Sifter’s portfolio?
It is clear that a lot of expectations are built into Novo’s stock price and business. The company’s current valuation is once again quite high, with a forward P/E of 30 as of August 2023.
When we look at this with a long-term perspective and use the fifth year earnings yield formula, we believe it gives us a better estimate of Novo Nordisk’s true value. Our earnings yield metric gives us a return of 4.8% in the fifth year. This estimate is calculated using the most conservative market growth expectations.
However, we continuously monitor Novo’s business development and, based on our research, we will decide whether to reduce the company’s weight in Sifter’s portfolio and transfer profits to other quality companies to generate returns for our long-term investors.
It’s good to remember that extremely high-quality companies are very hard to find, and Novo Nordisk is undoubtedly one of them.
