1 Green Flag That's Also a Red Flag for Pfizer Stock

This is a bit of a trying time for Pfizer (NYSE: PFE). While the last 12 months saw the stock market provide a stunning total return of 41%, the struggling pharmaceutical giant returned a piddling 1%.

Raining on the parade even more, Pfizer just reported some good news that seems to confirm the presence of some internal issues. So let's examine this new green flag that's also a red flag for anyone looking to buy the stock.

It may have just proved the point of a loud critic

On Oct. 29, Pfizer reported its third-quarter earnings. Though the consensus estimate for its earnings per share (EPS) from Wall Street analysts was $0.62, its diluted EPS was actually higher than anticipated, at $0.78. Similarly, it also announced that it was hiking its annual guidance for adjusted diluted EPS from $2.45 at the upper end to a maximum of $2.65, and hiking guidance for revenue from a peak of $62.5 billion to an upper bound of $64 billion.

Its antiviral pill for treating COVID-19, Paxlovid, and its COVID vaccine, Comirnaty, are also performing a bit more strongly than it anticipated.

It's definitely a green flag when a company does better than it initially calculated and expects the party to keep going, requiring an update to its estimated year-end totals. In Pfizer's case, the green flag has two positive components: better revenue, and better earnings. But it's exactly this green flag that, from a different perspective, can also be interpreted as a red flag for shareholders.

Recently, an activist investor group called Starboard Valley took a $1 billion stake in Pfizer, seeking to pressure management to make changes that would eventually drive the pharma's stock price upward. Starboard had a slew of criticisms, ranging from the inefficiency of the company's research and development (R&D) investments, to its suboptimal capital allocation strategy.

Importantly, Starboard also faulted management for forecasting and budgeting issues, which it claims caused a higher-than-average rate of quarterly results deviating from expectations and guidance statements. Coronavirus products were identified as an area of especially poor forecasting. With so many instances of mismatched forecasts and actual results, the activist investor group believes that management's reliability has been somewhat weakened.

With Pfizer's Q3 results, it looks like Starboard Value has another piece of evidence to support this argument. The fact that the business outperformed expectations and had to increase its guidance, rather than missing expectations and revising its estimate downward, no doubt softens the blow for shareholders. But it doesn't change the fact that once again, its projections were not as accurate as they might be, with the variability of sales of its coronavirus products shouldering much of the blame.

So the green flag from earlier is also a red flag: It contributes to the activist's case that Pfizer has some recurring management issues that need to be addressed.

There will be more developments worth watching

The forecasting mishaps outlined above don't preclude an investment in Pfizer's stock. After all, its coronavirus product revenue appears to have stabilized at a slightly higher-than-anticipated level after a decline over the last couple of years. And despite Starboard Value's complaints about Pfizer's R&D productivity, its pipeline is still packed with new clinical-stage medicines that are approaching their shot at getting approval. So far this year, it got approvals for eight new indications for its medicines, and more are on the way.

Furthermore, its cost-cutting campaign is in full swing, and yielding results. Management says that $4 billion in annual cost savings will be realized before the end of the year. That should help to keep its earnings growing slowly alongside its revenue.

But if you might need the money from an investment in this stock within the next five years, it's probably better to be cautious. Starboard Value is clearly at least partially correct in identifying some of Pfizer's problems, and it will take time for the company and its board of directors to work out an accord with the activist group to address the concerns. Or perhaps it might publicly double down on its existing strategy and its current set of leaders, in contradiction to what Starboard recommends.

Either way, Pfizer is in a moment of uncertainty and apparent weakness, so it isn't the right pick for those with a lower-than-average tolerance for risk.

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Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Pfizer. The Motley Fool has a disclosure policy.