Previously, i wrote about using a top-down investing approach that identifies key long-term trends and first mover companies that will most likely benefit from their early involvement & innovation. The following is a post on my next investing theme:
There’s a chip war brewing in the semiconductor sector and it’s a case of David vs Goliaths. And i’m talking about the intense competition in this space, brought forth by AMD against Intel and Nvidia.
Investing can be interesting and extremely fun, especially when one invest in exciting companies like those in the biotechnology sector.
Exciting companies usually have big ideas; innovative products/services that allow them to be valued at a premium and in most cases, overpriced. Investors and traders flock to these kinds of stocks because of their potenital to make quick bucks and high returns on their investment.
In the biotech sector, it’s the potential and ability to cure some of human’s biggest health threats like Cancer, Alzheimer, diabetes and or other widespread conditions and diseases that makes certain biotech companies exciting because of their innovative or novel approach to making drugs.
Just take a look at these ranking lists: Forbes Innovative Companies 2016 and MIT Technology Review’s 50 Smartest Companies 2016. You’ll find that there are many biotech companies (both private and public listed ones) pushing the boundaries of medical treatment.
Investing in biotech companies is not for everyone, especially risk-adverse investors. The unpredictable nature of drug development makes shares of these companies are extremely volatile.
Biotech companies are usually and almost always unprofitable. They burn buckloads of cash while spending years focusing on novel drug development with no guarnette of a successful discovery. It can take just 1 clinical trial to determine between between going bankrupt or commercialising a breakthrough drug to bring in billions of dollars in reveneue or profit for them.
So why invest in these companies at all? And can one really invest in such companies or are they pure speculation?
“With speculation, the risk of loss is more than offset by the possibility of a huge gain; otherwise, there would be very little motivation to speculate. While it is often confused with gambling, the key difference is that speculation is generally tantamount to taking a calculated risk and is not dependent on pure chance, whereas gambling depends on totally random outcomes or chance.”
Investopedia
We all know that speculatiuon in stocks is a bad idea. Speculation is a fine line between gambling and investing. It’s either one or the other and there’s a difference. Investing is about making a judgement and it’s no different with biotech. It’s about making an informed judgment rather than pure speculation.
Just take a look at these biotech multi baggers:
Biotech winners can result in multi bagger gains for those who invest in them for the long-term. Let’s not forget the fact that buyouts are common in the biotech space and will always result in significant spike in the share price of the target. Not convinced? Shares of Tobira Therapeutics jumped 720% in one day recently on news of a buyout by Allergan.
There are many reasons as to why i would invest in biotech stocks.
1. Objectives & Investing Style aligned
There are 2 objectives in my investment portfolio and that is to generate an ever growing “income” from dividend stocks and to have my investing capital appreicate several fold in a faster timeframe.
The capital appreication part invloves investing in growth companies, potential multibaggers, making a high return from a small investment amount.
Growth investing is about beating the broader market benchmark over the longer-term by investing in companies whose earnings are expected to grow at an above-average rate compared to its industry or the overall market. Biotech stocks, like any other growth stocks suits me perfectly.
I prefer to invest dividend paying stocks and “growth stocks” simulatenously as they are capable of generating higer returns. There are the 2 different approaches at play here and they serve different purposes in my portfolio.
In short, im constantly making sure that my dividends as time passes while on the other hand, accepting the risk associated with growth stocks.
2. Know what one can risk
Everyone’s investment objectives are different as they are dependant on one’s style, time horizon and most importantly risk tolerance. It’s my personal belief that there’s always room in one’s portoflio fot something risker simply because the return, from a successfully just from a small investment. And usually the companies that you speculate on are exciting and innovative companies.
However, just as for these kind of ‘bets”, one should also have a plan as to when they should sell.
1. Breakthrough drugs and the pipeline.
One way to invest in this sector is to focus on compaines that actually have filed an IND (investigational New Drug application) which allows for the commencement of clinical testing of developmental drugs in humans.
The companines that stand out among these companies? Those with innovative or breakthrough drugs over companies that have the United States’s FDA coveted “breakthrough” or the European EMA ‘PRIME’ designation. Drugs with these status is deemed to have significant improvement over existing drugs/therapies due to evidence in the preliminary clinical trials. They are also subjected to a faster review & approval process by the regulators. Therefore they offer the biggest and faster upside but are alsothe most volatile during market selloffs.
All trials consists of 3 phases, but even this designation does not offer any guarantee that the drugs do make it. However, it’a a great place to start with. Essentially we are looking for companies with leading drugs, potential game changing treatments and not those companies that are making biosimialrs nor generic drugs.
In addition, always look at the company’s drug pipeline as it tells what drug candidates the company has in development or discovery. It would be a risker investment If companies are relying only on a single drug. Ideally companies should have a huge Pipeline of drugs in development, mainly phase 2 drugs and above and not dependent on just a few because too many drugs failed to deliver what they were intended to do.
2. Solo or collaboration
While biotech startups can go solo on their novel approach to drug discovery, the risk is definitely higher because their technology is likely unproven and they require massive amount of capital for their research and to stay afloat.
Recent trends have seen biotech increasingly turning to collaboration with cash rich biopharmaceutical companies who are cutting RND expenses to be more profitable while still requiring to retain their “innovative” edge.
Collaboration often involves but not limited to the following where biotech companies:
In short, the richer big pharmaceutical companies get access to the new drugs and treatments and in return, supports the biotech’s in building its drug technology platform and drug research at a faster pace.
When biotech collaborate with pharmaceutical companies, they usually get milestone payments, which are pre-determined fees paid by deep-pocketed biopharma drugmakers for their collaboration partners after achieving specific goals. Milestone payments provide many useful insights. Not only does It speaks volumes about the technology and drugs under development by the biotech companies, it can help to determine the financial condition of the companies in the near-term.
If companies collaborate, then we as investors would need to determine who will reap the biggest rewards when a dugs becomes successful.
Valuation is a tricky business especially if companies are unprofitable. In the case of biotech companies, it is even tricker because some companies do not even produce any commercial drugs.
As investors, we should always keep a clear mind that any developmental drugs are in no way guaranteed to ever be approve or commercially produced. Valuation in most cases is theoretical, usually based on the peak sales potential of the drug (be it approved or not). This is determined by the drug’s addressable market; the number of patients receiving treatment in the markets the drugs are available in and the price of treatment per patient.
These factors will eventually translate to how much “protected” revenue it can generate for the company for a time period of roughly around 20 years, for thats when drugs go off-patent from their patent application.
If the drug is indeed effective and has approval for commercialization, It would usually be a leader and thus command a bigger market which means a higher price premium for its drugs. Any top selling drug can bring in billions of dollars year after year till peak sales are reached within a 20-year time period, which is typically the end point. That’s when drugs go off-patent which usually means that revenues will decline and will affect the biotech’s valuation drastically due to expected loss of revenue and profits. Thus having a huge pipeline of commercialise patent drugs will help to mitigate some of the risks.
so are you game on?
Update: It’s been a year since i first wrote this post. Since then, interestingly, i have 3 new stocks that have doubled returns on invested capital while 3 existing stocks (Apple Inc, Walt Disney Co & Bank of Internet Inc) have underperformed and dropped below 1x return.
I’m not at all concerned because i take a long-term view and so long as the fundamentals of the company has not changed, there is nothing to be worried. (This is except for the case of BOFI where they face accusations of accounting fraud which I’m monitoring closely)
I have also expanded my original article after reading 100 Baggers: Stocks That Return 100-To-1 And How To Find Them” by Christopher Mayer
In investing, is holding on to excess cash or having cash on the sideline necessarily a bad thing?
I used to believe that holding onto cash and getting paid next to nothing by the banks is not worth it. Instead of not doing anything, why not invest the money so that they can compound and earn me more money at the earliest opportunity?
This is why i prefer to buy shares of my favourite companies every month, no matter how the stock market is performing because I take a long-term view and thus i’m not affected by what happens in the near term. I can add to my winners,average down on lossers or invest in other high quality companies.
It used to be my belief that any excess money that is not required
should be invested. At the minimum, it should beat inflation! I used to be fully invested but recent lessons and experience had made hold onto some cash as a position.
Being full invested means that there are times when the market corrects and more often than not, there is not much that i can do but watch.
Holding onto cash is a way to option to take advantage of volatility in the market. I came to realised that having a cash position allows me to better take advantage of stock market correction or specific stock sell-offs to scoop up some bargain buys. (It’s like going to a sale in the stores!) It is in this context that cash is king.
Secondly, it’s a matter of time before the next market cycle happens. It always does. Having cash on hand also allows investors to be well prepared during downturns. It may well prevent us from being panic and thus resort to selling our investment. A cash position is a hedge against any major losses.
Call that market timing if you will, but as Leonard Turkel says:
When Opportunity knocks you can’t say ‘come back later’
Specific stock selloffs or market correction always and happens quickly. A cash position will ensure that we can make full use of the situation. This approach present the best opportunity to ensure that we have a wide margin of safey and a higher investment return when invested in the right companies.
Probably no one does it better than Warren Buffett (Berkshire Hathaway), who is well known for having a huge cash position and using them strategically at the right time when opportunity knocks.
So should one hold cash as a position?
There’s no better article in my option that address this issue other than legendary investor, Seth Karman’s (Baupost Group) 2004 year-end letter where he talks about the painful decision of investors to hold onto cash. (highly recommend that everyone read it in it’s entirety) :
He wrote this about investor’s option to hold onto cash:
The alternative is to remain liquid, defy the steady drumbeat of performance pressures, and wait for the prices of at least some securities to drop. (One doesn’t need the entire market to become inexpensive to put significant money to work, just a limited number of securities.) This path also involves risk in that there is no certainty whether or when this will occur; indeed, securities prices could rise further from today’s lofty levels, making the decision to hold cash even more painful.
..and here, he explains why investors usually won’t hold on to cash:
Most investors would make the same choice. Human beings are only endowed with so much patience, after all. Few are able to look past nearterm returns, and today anything appears to offer better returns than cash. Also, given their relative-performance-oriented, competitive nature, investors loathe the possibility of underperformance that comes from sitting on the sidelines; they find it better to be in the game (unless, of course, the market drops). Most significantly, they remain highly skewed toward the greed end (how much can you make?) and away from the fear end (how much can you lose?) of the spectrum of investor emotions. In short, investors remain the consummate yield gluttons, seeking high return without regard for the likelihood of actually achieving it or for the risk incurred in the process.
..lastly he talks about his perspective on this issue:
Some argue that holding significant cash is gambling, that being less than fully invested is akin to market timing. But isn’t a yes or no decision the crucial one in investing? Where does it say that investing means always buying something, even the best of a bad lot? An investor who can’t or won’t say no forgoes perhaps the most valuable tool available to investors. Charlie Munger, Warren Buffett’s long-time partner, has counseled investors, “Look for more value in terms of discounted future cash flow than you’re paying for. Move only when you have an advantage. It’s very basic. You have to understand the odds and have the discipline to bet only when the odds are in your favour.”
How much cash should one hold and how much is considered too much? Unfortunately there is no right answer. However, holding onto too much cash definitely poses a risk over the long-term.
It should be relative to one’s portfolio size which is why I currently strive to hold a cash position that’s at least 5% of my portfolio size and this cash position is not cash that makes up one’s emergency fund. They do not and should not be mixed. (One’s emergency fund should be at least 3-6 months of living expenses). It’s not easy to build up such cash position as it’s quite a substantial amount. it takes time but it’s every bit worth the effort.
Previously, i wrote about using a top-down investing approach that identifies key long-term trends and first mover companies that will most likely benefit from their early involvement & innovation. The following is a post on my next investing theme:
To be a successful investor requires a combination of factors. However, one can easily be a better investor by simply reinvesting dividends we receive (great for you, if you do!) from dividend paying stocks or even better, from dividend growth stocks. These are companies that are dividend growers, as in they pay an increasing amount for their dividends every year.
Effect of Compounding
Reinvesting
dividends is to simply take advantage of compounding, where the dividends
that’s paid out to us is used to accumulate more shares such that the next time a dividend is issued, it will be based on a bigger number of shares.
This approach bolsters our return over the long term. The ‘snowball’ effect is pretty significant if one stays patient and disciplined. It’s a time tested strategy.
Simply put, dividends, no matter how small they are, when reinvested can add up to big investment gains in the future.
SCRIP and DRIP
There is generally a effortless and cost effective (cheaper) way to reinvest our dividends instead of receiving the dividends in cash.
The SCRIP and the DRIP (Dividend Reinvestment Plans) are 2 different types of scheme offered to investors, depending on the company’s policy.
The difference between the two schemes is that, with a SCRIP, the company automatically issues new shares to investors at a previously determined price. On the other hand, a DRIP allows us to use the cash that will be paid out to purchase more shares, sometimes even in fractions in the existing market.
While different in terms of approach, both schemes allow us to receive additional shares from the companies paying the dividends instead of receiving a cash dividend payment. The only difference is that if one chooses to opt out of a SCRIP, their percentage of shares get diluted due to new shares being issued.
Personally, as a global investor, it seems that not all companies offer such schemes. The ones that do in Singapore and UK usually offer SCRIP, and all (if not most) US companines offer the DRIP, which are more common these days since the tax changes in the 1990s have made SCRIPs less attractive.
While less attractive to companies, SCRIP dividends is in my opinion a better option for investors.
Fees, Transaction Costs
Costs matter to all investors. They eat into our returns and they should be minimised as much as possible.
SCRIP is in my opinion a better option because the new shares issued do not incur transaction costs nor stamp duty (if applicable) that would normally occur if they purchased these shares in the market.
Shares issued under DRIPs are taxed, and also subjected to transaction costs such as brokerage commission, including stamp duty (if applicable) because shares are purchased from the existing market.
Overall, they are still more cost-effective than receiving cash dividends, if one takes into account the transaction costs payable the next time the cash are use to purchase shares again. However for new/small investors, the dividends paid out are usually quite low and probably cannot be reinvested. In this case, it would make sense to accumulate the cash payout till it is economical to initiate a new purchase. Usually the commission costs should not be more than 2% of the invested amount.
The perfect approach?
As with any approach, there are also some drawbacks to automatically reinvesting of dividends. Generally the advantages far outweigh the disadvantages in my opinion.
Firstly, with the SCRIP/DRIP scheme, dividends are automatically reinvested on our behalf. This means that the dividends maybe be reinvested at a time when the shares are over valued. Instead of reinvesting the dividends, the cash payout can be used to purchase the shares when it hits a lower price point or there can be put to better use on some other stocks. For new /small investors, the amount being paid out maybe be quite low (in terms of the value), it might be better to selectively re-invest the dividends to different stocks to have a diversed portfolio of stocks.
In some cases, if you are like me that holds Singapore stocks, you may be stuck with odd shares (out of the 1 lot requirement) that cannot be transacted.
Secondly, reinvesting the dividends back to the same stock might leave a portfolio unbalanced, with some of the stocks taking up a bigger percentage in the portfolio, leaving the portfolio highly dependent on the outcome of those major holdings. This is especially true if one has a portfolio of stocks like mine which contains companies that pays dividend and those that do not.
The eventual goal of reinvesting dividends or having dividend paying / growth stocks is to generate a increasing amount of passive income in the future. When shares get reinvested, the dividends received gets higher as a result, which can also lead to a scenario where a higher percentage of passive income comes from a certain company. Definitely not very wise.
To sum it, dividends is a key driver of equity return for all investors. Reinvesting dividends is one easy strategy that everyone can employ over the long term.
Previously, i wrote about using a top-down investing approach that identifies key long-term trends and first mover companies that will most likely benefit from their early involvement & innovation. The following is a post on my next investing theme:
“When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.” - Warren Buffett
When there’s someone that you count on to create wealth for you in the long run, it’s the CEO that you have to look at.
Happy Weekend! Sharing some of the interesting stuffs that I have came across for this week. I’ll try doing it on a regular basis, hopefully every week.
Spreading the importance of being invested, with my own perspective on various topics like saving, investing styles while not forgeting to share great companies to put our money in for the long-term.
