After reassessing the long-term historical return characteristics of Big Pharma stocks and their relationship with the overall market, we are lowering our cost of equity assumptions to better reflect the defensive nature of drug companies relative to the overall market.
We believe low systematic risk accurately reflects the relationship between the pharmaceuticals industry and the overall economy as pharmaceuticals spending tends to only moderately correlate with macro-trends given its essential nature, and the earnings volatility for the industry mainly stems from individual company characteristics rather than swings in economic growth.
Financial leverage, another lever in our systematic risk calculations, also tends to be at the low end of the spectrum for the industry, supporting our new systematic risk thesis. With the exception of 
Bayer (BAYN) (which carries a higher degree of systematic risk, in our pinion), we believe that a corresponding 8% cost of equity is a more appropriate benchmark for long-run returns for the industry.
While we had already assumed a low cost of equity for Novartis (NOVN) and Johnson & Johnson (JNJ), we plan to use a similar cost of equity for the majority of the remaining Big Pharma firms.
As a result of this change, we plan to moderately increase valuations across the pharmaceutical sector. We note that this change doesn't stem from any material modifications to our underlying model assumptions, including moat ratings. We note that while on average our industry valuation increases 9%, our median Morningstar Rating for stocks remains at 3 stars, implying that the group remains by and large fairly valued. However, Sanofi (SAN) remains our top pick in the industry and trades at just over a 15% discount to our updated fair value estimate.
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