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Amgen's (AMGN) stock is undervalued, and investors should take advantage of its current selloff and begin to accumulate shares for the long term. 

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Amgen has proven to be a very reliable and consistent company in terms of earnings and free cash flow growth. Over the past 10 years Amgen has grown earnings and free cash flow at an average rate of 12.3% per year. If Amgen is able to sustain this 12.3% growth rate -- and the company's impressive track record indicates this is possible -- then the stock is indeed undervalued.  

This undervaluation is best illustrated by looking at Amgen's earnings-based and free cash flow-based discounted cash flow valuations, which take its 12.3% average growth rate into consideration. 

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Courtesy of

As the above calculation shows, Amgen's earnings-based discounted cash flow valuation implies a fair value of $161.95, which is 8% greater than the current stock price. 

When examining Amgen's free cash flow-based discounted cash flow valuation, the stock is even more undervalued. The formula is the same as the one above but substitutes Amgen's earnings per share of $9.45 with its free cash flow per share of $11.54.

This valuation implies a fair value of $197.71, which is about 32% greater than the current stock price. 

Besides being undervalued, Amgen is also a very high quality and profitable business. The metric that best represents this is the return on capital. 

"Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over 40 years, you're not going to make that much different than a 6% return -- even if you originally buy it at a huge discount. Conversely, if a business earns 18% percent on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with one hell of a result."

- Charlie Munger, vice chairman of Berkshire Hathaway

 Amgen's Return on Capital

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As shown in the chart above, Amgen earns a very healthy rate of return on capital, and this will lead to strong stock performance over the long term. 

Another positive for Amgen is that it is a very resilient company. This is best shown by looking at its return on equity, which almost passes Warren Buffett's test of economic excellence. 

In Berkshire Hathaway's 1987 Letter to Shareholders, Buffett laid out two criteria that a company must meet in order to have economic excellence. First, it had to have an average return on equity of 20% over 10 years. Second, the return on equity for any single year couldn't be less than 15%. 

It is very rare to find a company that can meet these standards, but the ones that do tend to outperform the market. 

Citing a Fortune study, Buffett wrote in the letter, "Only 25 of the 1,000 companies met two tests of economic excellence -- an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15%. These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P 500."

Amgen's Return on Equity

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As shown in the chart above, Amgen just barely misses the mark, but nonetheless these numbers are impressive and bode well for the performance of the stock.

Other signs that point to Amgen being a favorable investment right now are that its price-to-earnings ratio is near a three-year low, its price-to-book ratio is close to a three-year low, its price-to-sales ratio is near a two-year low and its dividend yield is close to a five-year high. 

Amgen is a very high-quality business, and buying shares at this discounted price should lead to healthy long-term returns. 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.