This 10-Time Winner is Offering a New Opportunity

Investors have a tendency to fixate on the negative instead of seeing the bigger bullish picture. Because of this, they often overreact to the slightest bad news and rush for the exits. 

For the more level-headed traders out there, this can lead to great opportunities.

#-ad_banner-#

Gilead Sciences (NASDAQ: GILD) is a prime example of this. Due in part to investor overreactions, this biopharmaceutical company may be one of the most undervalued stocks in its sector.

Gilead offers consistent earnings growth, and analysts expect it to earn $12.08 per share this year and $12.42 per share next year. With shares trading at $82.70, GILD has a forward price-to-earnings (P/E) ratio of less than 7, which is a bargain considering that the average forward valuation in the biotech industry is 25. Other large drug companies with stable earnings — like Merck (NYSE: MRK) and Pfizer (NYSE: PFE) — often trade with forward multiples above the industry average.

If GILD were valued at just half the industry average (which I believe is a fair assumption), shares would trade around $150 — more than 80% above current prices. That should give you an idea of just how discounted shares are.

However, when the company reported earnings in late April, traders fixated on anything that could be perceived as negative, leading to a massive gap down on the charts.

As is often the case, though, investors reacted to the headline numbers rather than digging deeper.

What investors saw: Sales for Harvoni, Gilead’s once-daily, single-pill regimen for hepatitis C, fell 15% in the quarter because of discounts given to private insurers and government-run health plans like Medicaid.

What I saw: Although Harvoni revenue was down, the number of new patients starting treatment was up 10% in the quarter, which is most likely a result of the deep discounts. At the lower price, insurers are loosening their guidelines and allowing more patients to benefit from treatment. The increase in prescriptions seen over the past quarter could mark the beginning of a new trend in treatment, which would be bullish for GILD. Higher volume will help boost revenue and could offset the impact lower prices have on GILD’s bottom line.

Sales of Gilead’s older hepatitis C drug, Sovaldi, actually increased — a sign that cost-conscious insurers might prefer trying the cheaper alternative. Before discounts, treatment with Sovaldi costs $84,000 and Harvoni costs $94,500.

Additionally, there was an indication that Gilead could increase its market share in hepatitis treatment. Doctors have found many patients enjoy the full benefits of treatment after just eight weeks, and the company reported more than 40% of new patients plan just eight weeks of treatment instead of 12 weeks. This lowers costs further for insurers and increases the number of patients they can cover. Shorter courses of treatment also offer a way to differentiate the drug from new drugs being sold by Merck and AbbVie (NYSE: ABBV).

Gilead remains the No. 1 choice for providers treating hepatitis with a 90% market share. The company is also the largest drugmaker in the HIV market with a 74% share in the United States. The company’s drugs are already the top three most-prescribed drugs for HIV, and a recently introduced drug could further increase Gilead’s market share.

What investors saw: Earnings per share (EPS) came in at $3.03, below analysts’ estimates of $3.15.

What I saw: As a result of a pending patent infringement lawsuit with Merck, Gilead set aside all of the funds required to pay $200 million in damages last quarter, reducing earnings by $0.14 a share, an amount that completely explains the $0.12 earnings miss. 

These damages will be reviewed and could be reduced on appeal, which appears to be happening already. A judge reopened the case after some questions about the evidence were raised, and the outcome will likely be favorable to GILD.

I expect shares to rise from these severely undervalued levels, presenting an opportunity for bullish traders.

This is far from the first time investors have overacted to “bad” news and sold off shares. In fact, I have successfully traded GILD 10 times under similar conditions.

But I don’t buy and hold shares. Instead, I sell put options. 

As you may already know, put options give buyers the right — but not the obligation — to sell a stock at a specified price before a specified date.

When we sell a put contract, we receive cash upfront.

Selling a put means we’re expecting the stock not to fall to a certain price. If it does, for every contract we sell, we have to buy 100 shares at that price (which isn’t a bad thing when the stock is one you want to own anyway, like GILD).

If the stock goes up, or doesn’t sink to the price we specified, we pocket the income we received as pure profit.

Like I said, I’ve done this 10 times with GILD, starting in January 2014:

If you had sold just one contract of each, you would have earned a total of $664 — without ever doling out a cent to purchase the shares.

This strategy is easily scalable too. If you sold five contracts, you could have made $3,320, and if you sold 10, you would have pocketed $6,640 — again, all without ever owning shares of GILD.

Now GILD is offering up a bullish opportunity, which I expect to boost my record to 11 for 11.

This time around, I see an opportunity to sell the May $80 strike put option (GILD May 80 Put) for about $0.35.

Selling these puts will generate immediate income of about $35 (each contract controls 100 shares). This put will obligate you to buy GILD at $80 a share if the stock trades for less than that on May 20 (the last day these options can be traded).

Buying 100 shares of GILD at $80 each would cost $8,000. To initiate this trade, your broker will likely require you to deposit a percentage of that obligation in your account, like a down payment on a house. This is called a “margin requirement.” It usually runs about 20% of the amount it would cost you to buy the shares. This GILD trade would require a margin deposit of $1,600 (20% of $8,000).

As long as GILD doesn’t fall 3.3% to $79.99 or less in the next week, we will pocket that income free and clear. In this case, the $35 represents a 2.2% gain on the $1,600 in five days. If we can repeat a similar trade every five days, we’d earn about 160% on our capital in 12 months.

I recommend trades like this every week in my Income Trader service. If you’re interested in learning more about how to get started selling puts in your portfolio or get my weekly recommendations, follow this link.