Industry Audit - Pharmaceutical Executive


Industry Audit
The Company of the Year: Our fifth annual report dives deep into the numbers and comes up with the industry's true top performers.

Pharmaceutical Executive

Assets to Net Worth Assets to Net Worth is not a metric in our audit. It merely shows how much debt a firm carries. Drug companies are very conservative in taking on debt. As in the past few years, Wyeth carries the most debt. Even so, its ratio of 2.99 is still very conservative.

Profit to Net Worth Profit to Net Worth is calculated by multiplying Profit to Assets by Assets to Net Worth. This shareholder-value performance metric varies with a firm's debt load. Merck, GSK, and Wyeth placed in the top three.

Revenue per Employee Sales per employee is a metric that stock analysts are using more and more. No surprise that the three biotechs blow everyone else away. With their relatively small sales forces and astronomical prices, Amgen, Biogen Idec, and Genentech are in a class by themselves. Their work forces are even more productive than research firms.

Finishing in fourth place in employee productivity is Forest with $623,053 per employee—almost in biotech range—followed by Pfizer, BMS, and J&J.

Proportion of Earnings Driven by Intellectual Capital In the past, we have used a different metric: number of products less than five years old. That metric is problematic for a number of reasons. One problem is that a one-drug firm like Forest or Biogen Idec, that may have had its drug approved within five years, shows a 100 percent revenue from new drugs—a bit misleading. Conversely, a one-trick firm whose new drug is in its sixth year would register zero percent.

More useful would be a metric that takes into account a company's intellectual capital. Such a metric would encompass the value of drug brands, the corporate brand, pipeline, and other indicators of innovation that may not be limited to technology or science.

One such approach is based on the work of Baruch Lev, Accounting Professor at New York University's Stern School of Business (see "Accounting Gets Radical," Fortune, April 16, 2001, for an excellent, user-friendly article on his methodology).

Lev starts with a firm's net income before taxes. Then he allocates how this income is derived over the three basic kinds of assets that produce sales: cash assets; property, plant and equipment assets; and intellectual property. According to Lev, cash assets earn an average of 4.5 percent. So 4.5 percent multiplied by a firm's cash assets gives an approximation of income due to cash assets.

Property, plant, and equipment over the years, net of depreciation, gets a similar treatment. They earn on average 7 percent. So 7 percent times the value of property, plant, and equipment gives you the income driven by these assets.To calculate the return on intellectual property, take net income before taxes, subtract the return on income due to cash assets and income due to property, plant, and equipment, and divide by net income before taxes.

Using that formula, the "smartest" drug firm for 2005 was Forest with 90 percent of its income driven by "innovation," followed by Amgen, J&J, Abbott, BMS, GSK—with Genentech in 7th place. But how can a firm like Forest, which spends virtually nothing on R&D, but has the acumen to spot sleepy, unexciting drugs that other companies pass over, be the "smartest"?

To make sense of this, we turn to a fascinating study reported by BusinessWeek (April 24, 2006) on the 100 most innovative companies in the world.


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