Ignore the Smartest Guys in the Room, All 8,600 of Them

Marc Lichtenfeld
by Marc Lichtenfeld, Chief Income Strategist

Everyone loves the long ball. Home runs are exciting.

Sammy Sosa and Mark McGwire’s steroid-fueled race in 1998 brought baseball back from the damage caused by the players’ strike a few years earlier.

Tony Gwynn’s hitting singles and doubles en route to a .368 batting average in 1995 didn’t excite anyone…  While fans respect the hitters who get on base, they buy tickets to see someone smack the ball over the fence.

Healthcare investors are often the same way.

With 8,600 institutional investors jammed into presentations at the J.P. Morgan Healthcare Conference this week, it became apparent that the more speculative an opportunity, the more interest and buzz.

Sure, the big pharmaceutical companies attracted an audience. After all, those stocks are in a lot of pension and mutual funds.  But those 8,600 people - most of them usually the “smartest guy” in the room - want to hit home runs with their biotech investments.

And that’s fine for many of the hedge funds that they run. But individual investors are better off investing in companies with steady and growing earnings and cash flow, rather than hoping that their favorite biotech stock is going to be the one to cure cancer.

Companies like Medivation (Nasdaq: MDVN) and Onyx Pharmaceuticals (Nasdaq: ONXX) drew standing-only crowds. And in fairness, they’ve made their shareholders a lot of money over the past few years. But for every Onyx and Medivation, there are many Isis Pharmaceuticals (Nasdaq: ISIS) and Keryx Biopharmaceuticals (Nasdaq: KERX) that have failed to deliver on shareholders’ (and patients’) hopes.

Several hours ago, I was in a San Francisco watering hole, filled with fund managers and analysts. In between sips of Old Fashioneds, they feverishly discussed the prospects for various companies. Not once did I hear “Merck” (NYSE: MRK), “Pfizer” (NYSE: PFE), or “Cigna” (NYSE: CI) – companies that have been grinding out earnings and cash flow for decades.

Instead, the talk was about Dendreon (Nasdaq: DNDN), Amarin (Nasdaq: AMRN) and Vivus (Nasdaq: VVUS). These investors told a few war stories of stocks blowing up on them after reporting bad data. And told even more tales of incredible returns - perceptively picking the right stock early on, before it soared to magnificent heights.

But most investors are better off putting their money into tried and true healthcare companies. Ones with solid business, that won’t get sunk with one or two failed clinical trials.

Sure, it’s not as exciting. But if you want excitement, go skydiving. For most investors, the purpose of investing should be to safely grow their portfolio. Not foolishly try to double and triple their investments in short periods of time.

If an investor has some money to play with and loves following the sector (and many do – after all, it’s exciting to keep track of the latest medical breakthroughs), then they should go ahead and dabble. But only if they’re fully aware that potentially tremendous rewards come with elevated risk.

But for most investors who cringe at the idea of speculating, healthcare investments should stay in large- or mid-cap companies that have real businesses. Just like any other sector.

Most investors wouldn’t buy stock in a retailer that hasn’t opened its doors yet. So, those investors should also stay away from biotech companies that don’t have any products to sell.

There’re still opportunities to make good money in the biotech sector. There are great companies that are doing exciting things, and earn a profit while doing so.

Biogen Idec (Nasdaq: BIIB) has some great drugs for multiple sclerosis. In the last 12 months, the company generated over $5 billion in revenue, over a billion in cash flow, and is expected to grow earnings over 10% in 2013. Over the last 12 months, the stock is up 28%.

Gilead Sciences (Nasdaq: GILD) practically owns the HIV space. It generated over $9 billion in revenue, $3 billion in cash flow, and is forecast to grow profits by nearly 14% this year. The stock is up 80% in the past year.

So stick with solid businesses that grow sales, profits and cash flow, just like you’d do in any other sector. Leave the small speculative names to the “smartest guys in the room,” so they can all have something to brag (or more likely, embellish the truth) about in the bar next year.

Good Investing,

Marc

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