GETTY IMAGES / DAVID MALAN

One explanation for the gap between strong revenues, high profits, and the low estimation of real value is the dead weight of uncertainty imposed by larger structural trends buffeting the industry. These include the patent cliff, lagging R&D productivity, more crowded therapeutic categories, phase-in of US health reform, and slower uptake of new products due to reimbursement pressures. Equally evident is that industry efforts to build a better value proposition—through consolidation and aggressive cost-cutting—is not a sustainable strategy for the long term. Hence the gnawing question: What will it take to put more "jig" in the jigsaw for puzzled investors?

This year's Audit is a study in continuity. Once again, one of our "stealth pharma" companies (see Pharm Exec's June 2009 issue, for a full profile of this group) takes the top honor, with Gilead repeating its win from last year with a tightly focused therapeutic franchise and formidable cost controls, reinforced by a strong Profit to Sales ratio. As it happens, the Audit's findings are reinforced by Pharm Exec's cover story in this issue on Gilead (in this isuue), its strategy, and line management.

REMS Revolution

A key lesson from this year's Audit is that staying lean makes you a mean competitor. Clearly, the smaller companies among the 24 carry an advantage in the rankings due to their ability to target and fill discrete market segments with niche products that carry a price premium, with fewer of the fixed overhead obligations (including a large sales force) required to prevail under the blockbuster model. While the Big Pharma giants, led by Pfizer and Merck, did score solid improvement in metrics that measure efficient management of costs and assets, our stealth pharma competitors as a whole did better—perhaps because smaller ships can steer faster through a turbulent business current and are quicker to recognize when ballast turns to bloat. But don't count the big players out. Size and a large cash hoard can provide cover for a raft of product failures, operational inefficiencies and strategic false starts while providing the resources to compete in a high-risk business where success requires global scale and reach. — William Looney, Editor-in-Chief

This year's Audit analyzes the calendar year 2009 performance of 24 publicly traded companies that file 10-K or 20-F reports on an annual basis with the US Securities and Exchange Commission. As in past years, the Audit includes a wider array of performance metrics than found in the standard financial and accounting statements. Drawing on this larger set of sources allows for a more meaningful picture of performance, analyzing such key metrics as Enterprise Value in Proportion to Sales—a critical portent of future prospects that focuses on profitability growth through product and process innovation.

In addition to the 10-K and 20-F reports, the Audit relies on proprietary and non-proprietary databases, as well as a broad array of secondary sources ranging from the business press to investor reports. Every effort is made to apply these sources uniformly to each company surveyed; this year, however, data on Novo Nordisk was derived exclusively from http://Dailyfinance.com/ and market capitalization rather than citing Enterprise Value due to the company not supplying its figures to Yahoo Finance as the Audit was being completed.

The key difference in this year's Audit is a reduction in the number of companies examined from 27 to 24, due to three significant M&A transactions: the acquisition of Wyeth by Pfizer, and Schering-Plough by Merck, as well as the transition to full ownership of Genentech by Roche. It should be acknowledged that consolidation has enhanced the weight of the 10 stealth pharma companies included in the Audit roster.

The Pharma Industry Audit is also uniquely positioned to demonstrate whether a company's business strategy is actually enhancing shareholder value. If there is one metric that's equivalent to food and water on a desert island, it's Enterprise Value. In the case of management, the measurement of success is simple: Do you create shareholder value or destroy it? For this reason, the Audit gives highest priority to just two metrics: Change in Enterprise Value and Enterprise Value to Sales. These numbers reflect a firm's market capitalization plus liabilities minus cash, or about what it would take to buy the firm on the open market. The Return on Assets metric is another worthy exemplar of a commitment to long-term profitability, and thus is given significant weight in the Audit.

The rating formula covering the eight metrics reflects the fact that some aspects of company performance are more important than others. Three of the metrics, covering value recognition and asset performance, are weighted at three; while the remaining five metrics are weighted at two. Two other metrics are not weighted; these are basic macro indicators covering scale and size that allows for viewing company performance in the context of overall industry trends.

Thus, determination of the final standing for each company relies entirely on the metrics—but not all metrics are equal. For example, if a company places 10th out of 24 on a metric weighted at three, it receives (10 x 3), or 30 points. Each company's points across all of the metrics are then totaled for a final score, with the company receiving the highest number of points overall designated as Company of the Year.