My Approach for Investing in Emerging Biotechnology Stocks
Other Aspects of My Investing Approach
How I Go About My Work
About SmithonStocks Subscriptions
Warren Buffett Quotes
My name is Larry Smith. I spent the first 25 years of my career working on Wall Street as an analyst with a primary focus on biotechnology and pharmaceutical stocks. However, I have also covered companies in several other industries. Most of this time was spent with Smith Barney and Hambrecht & Quist. Early in my career as an analyst, I was voted on the Institutional Investors All-Star team for pharmaceutical research for nine years in a row with my highest ranking being #2.
I became very interested in biotechnology in its infancy. I actually called on Genentech before they came public. I was also the analyst at Smith Barney when Amgen came public and was the first analyst to cover that company. The Wall Street Journal selected me as #2 in biotechnology stock picking earlier in my career.
Later in my career at Smith Barney, I was Executive Vice President, Director of Equities and Fixed Income Research, Chairman of the Investment Policy Committee, a member of the Board of Directors, on the Operating Committee and on the Commitment Committee. At Hambrecht & Quist, I was a Managing Director, Manager of Life Sciences Research, on the Operating Committee, on the Commitment Committee and was also Chairman of Annual H&Q Life Sciences Conference for six years.
In 2003, I founded DLS Research, LLC, a subscription research firm that performs due dilligence for institutional investors. Since 2003, I have interacted with over 150 biotechnology companies and track another 100 to some extent. SmithOnStocks is a new business direction for DLS Research.
I received a B.S. in Mechanical Engineering from Purdue University, an M.S. in Mechanical Engineering from Stanford University and an MBA from Columbia University.
Welcome to SmithOnStocks
I want to welcome new subscribers to my website. SmithOnStocks.com has been a process two years in the making and has taken me into the new world (for me) of the internet website. Designing the website and getting it functional has been much harder than I had envisioned and has taken much longer than expected. The launch has not been without glitches but the site is reasonably functional and we are all working to make it better for subscribers.
The current content is only scratching at the surface of what I am dreaming about providing. My longer term goal is to create a biotechnology website that brings together a group with a keen interest in biotechnology in a forum that will address matters with civility and balance. I envision this group to comprise not only investors, but also biotechnology executives, key physician opinion leaders and others.
I have written frequently on Seeking Alpha and have found that there are many very intelligent, thoughtful and courteous people using the site. Their comments add great value to my articles and they have taught me much. I have used Seeking Alpha to reach people, who like me, have an interest in emerging biotechnology. For the time being, I am continuing to write articles for that site, but I will move most of my content to my website. I hope to create a more focused and more informative website for investors interested in emerging biotechnology.
One of my longer term goals is to bring my contacts into your computer room. I have spent nearly 30 years on Wall Street and have met some interesting people, both investors and biotechnology executives that may give you some investing insights that could be of value in your decision making. Over the last decade, I worked as a consultant to an investment banking firm that provided financing to emerging biotechnology companies. In that period of time, I called personally on over 150 different companies and have seen even more present at conferences. I have made some close relationships with biotech executives and will try to find ways for you to gain insight and information from them.
Over my career, I have been involved with a large number of companies, some of which have succeeded and others that haven't. I was the analyst at Smith Barney when we brought Amgen public and got to know very well its key founder George Rathman, whom many consider the father of the biotechnology industry. I called on Bob Swanson, the key founder of Genentech, before that company went public. These are the obvious great success stories, but if you deal with biotechnology, you know that there are going to be failures. I have a great deal of experience and strive to be right on every call that I make, but experience has taught me that in order to succeed you have to take risk and I will make mistakes.
Emerging biotechnology is one of the riskiest types of investing as I am sure you have learned. There are amazing stories of success in which stocks can go up several fold in a few years and more stories of failed or bungled clinical trials that send stocks into freefall. From the bumps and bruises I have accumulated and those sheer moments of exaltation when things go right, I have evolved an investment strategy for approaching investing in emerging biotechnology. I call it asymmetric investing.
I research biotechnology and pharmaceutical companies of all sizes, but I have spent much of the last year focusing on small biotechnology companies ranging in size from as small as $50 million in market capialization.to about $500 million. There is much less analyst and investor attention on these stocks which can lead to pricing inefficiencies. There is also considerable risk as the investment thesis for the stocks often hinges on the outcome of a single clinical trial, the dreaded binary event. While I don't have precise statistics, my impression is that more than half of late stage clinical trials fail. These investment opportunities fit my asymmetric investing approach.
What do I mean by asymmetric investing? Some hedge funds have made enormous returns by looking for asymmetric investment opportunities. These stem from finding upcoming events that are not well understood and which have the potential to cause dramatic stock movements in the case of a positive outcome. The chance for such a positive outcome may be modest, but if it does occur the potential reward dramatically offsets the risk of being wrong. Perhaps the upside opportunity is a several fold increase in the stock price and the downside is losing much of one's money. These characteristics are similar to an option, but have the advantage that there is not the time element. One can be right on thinking that leads to an option investment and still lose all or much of your money if the option expires prior to an anticipated event. Asymmetric investing is not devoid of time risk, but it is much less than with an option.
For an asymmetric opportunity to exist there has to be lack of awareness or extreme skepticism that a positive outcome can occur. Small biotechnology companies fit this approach because most Wall Street analyst coverage in biotechnology is focused on larger biotechnology names that are earnings driven. In addition, the large number of trial failures conducted by small biotechnology companies has produced a pervasive skepticism as to whether any clinical trials will succeed. (This is basically the Adam Feurstein strategy). Asymmetric investing does not mean that an investor is smart enough to predict with certainty clinical trial outcomes. The premise is that the event has a reasonable chance of occurring, is unexpected, and if it does occur; the upside potential dramatically offsets the risk of losing much or all of the investment if the outcome is negative.
When I write my articles I always think that each idea will be successful, but I know that some will fail. At least, that is how it has worked in the past. It has been my experience that one winner will significantly offset the loss of several losers (an asymmetric outcome) and I aspire to be right more than half of the time. I tend to take small positions in many companies so that I am not overly exposed to any one stock and in the aggregate, biotech is about 15% of my portfolio which contains much of my personal wealth and I currently own over 15 biotech stocks. No one position is so large that if the stock blows up, it will have a major impact on my portfolio. A blowup can typically result in a 50+% stock price decline. However, if the outcome is positive the asymmetry that I am looking for can cause a noticeable effect on my portfolio.
I want to emphasize that if you are looking to trade the biotech stocks that I am involved with, my articles are probably not for you. I am generally locked in on an event or series of events that will prove me right or wrong and these can sometimes take some time to unfold (certainly months and sometimes a year or more). Along the way, unavoidably there will be many uncertainties and surprises that lead to sharp up and down movements in stock price and periods when a stock is just plain boring. I tend to ignore these and as long as the reasons that I bought the stock remain in place, I just shrug my shoulders and hang in there. I know that some people try to trade swings in the market and stocks in an attempt to enhance their total return. I have actually tried on occasion to do this as I suspect everyone else has. However, I found that it just didn't work well for me.
While trading is neither my goal nor my forte, it does not mean that I am uninterested in short term stock movements. There are times when I emphasize my buy recommendations because I anticipate an event that may cause near term strength in the stock. Other times, when I think that the stock might be ahead of itself on a short term basis, I usually go quiet. As a rule, I don't try to trade in and out of stocks in an attempt to catch a short term move as long as I believe that my long term thesis is intact.
I don't want to give you the impression that my whole investment strategy is based on swinging for the fences. I invest in a broad range of health care companies including the large pharmas and 75% of my portfolio is in non-health care names. I started my career as an analyst covering large capitalization pharmaceutical companies and try to keep abreast of them. In my Seeking Alpha work, I recommended Bristol-Myers Squibb and Johnson & Johnson about two years ago. These remain core parts of my portfolio and I think they remain attractive purchases for the long term. Still, the great inefficiencies in the market are in emerging biotechnology and this is where most of my written work is concentrated.
There are many principals that affect my research and my investment conclusions. In the following sections, I try to give you an insight into how I think. I can't list all of my peculiarities but a few are as follows:
- I try to understand the negatives and positives of investments. For every stock there is a bear case and a bull case and there is some justification for each point of view.
- There is no certainty. No matter how hard one works and the quality of information that one has access to, there are always factors that are not predictable. Let me give you an example. Bristol Myers with all of the resources available to it in terms of money, drug development expertise and scientific input made the decision to acquire Inhibitex for $2.5 billion in January 2012. Barely eight months later, a toxicity issue involving INX-189 (a nucleoside polymerase inhibitor)- the HCV drug that was the primary reason for the acquisition- destroyed the value of Inhibitex and BMY wrote off almost all of this investment. As biotechnology investors we bear risks, usually not this dramatic, in every investment we make. We are not investing on certainty but rather on the probability that something will occur.
- There is a great deal of emphasis on trading in the current market milieu. I think a classic example of this is the Fast Money program on CNBC. The participants on this show are very short term and are in and out of trading positions on a weekly, daily or hourly basis. It is interesting (not surprising) that they provide no way of judging the outcome of their recommendations with a written report or a model portfolio. My experience is that traders like these buy high and sell low. There is an irresistible temptation for people (traders) to do what is comfortable and to go with the consensus or momentum of a stock. This leads them to buy at market tops and sell at market bottoms and to do today what they wish they would have done yesterday.
- The person I respect most in the investing world (I am not alone) is Warren Buffet. Mr. Buffet looks at investments, not as pieces of paper, but as companies that he wants to own or be a part of for many years because of the quality of their business and long term prospects. This is in contrast to traders that look at stocks as a piece of paper that they are renting for a short period of time.
- I have patience in my investments. I can't call every twist and turn in a stock price. No matter how successful a stock recommendation may ultimately prove to be, it never shows a linear rise in stock price. Even with the best recommendations, there are moments of uncertainty and terror. You have to have the courage of your conviction and not let the stock price behavior affect your fundamental judgment.
- Don't come to a quick decision on a Company on the basis of a first impression. Company (and analyst) presentations too often present a clear cut and one sided view that don't balance the positives and negatives. If you are positive on a stock be sure that you understand the bear case before you invest. Don't think that you can look at a company for the first time and understand it.
- You should not anticipate a stock pick of the week from me. I will try to find a number of stocks each year that you may consider investing in. I know that you will want to know how many and all I can say is that it won't be 52. I try to go in-depth on the companies I write on and keep a steady flow of information coming.
- I don't use technical analysis. Some feel that it can augment fundamental research and lead to better outcomes. I will leave that to you.
- Most of all, don't invest blindly on what I am recommending. I make mistakes. I am not the Delphi Oracle. I do not always clearly understand all of the issues affecting a company (no one does). If there is one central principal of SmithOnStocks, it is that I try to give you as many facts as possible for you to make your own reasonable assessment. I have my opinion, but ultimately you have to feel comfortable and make the decision yourself on buying and selling a stock. Use me as one of your resources to lay out the facts in a balanced manner, but depend on your own judgment.
As a final point, I know that many readers have followed my writing on Seeking Alpha (2,075 followers), Twitter (5,000 followers) and my website subscribers for free content (1,200 followers). For the last two years, my writing and thoughts have been free. I have spent this time building a brand and allowing you to see if my work is valuable to your investing. There has now come a time when I am asking to be paid for my hard work.
I am now turning to a subscriber model in which I am asking for an annual fee of $149.99 for an annual subscriptions and $29.99 for a monthly subscription that will allow access to any prior subscriber reports. It takes me several weeks to conduct the research to write my reports and it has taken 30 years to gain the experience to put the research in perspective. While I will continue to write on Seeking Alpha and provide some content free on my website, the most valuable content will now be behind a pay wall.
I am a buy and hold devotee of Warren Buffett and aspire to accomplish just a small percentage of what he has accomplished. It may appear to be oxymoronic to use some of his investment principals in my biotechnology investment strategy. I think that Mr. Buffet would rather walk barefoot on hot coals than buy biotechnology stocks, which are among the most speculative of investments. And yet, I think that we can still benefit from his thinking in an approach to biotechnology investing. I offer up some of the master's great thoughts and humbly offer some corollary thinking on my part. I would also say that the importance of Mr. Buffett's principals can vary greatly as they are applied to different companies and are sometimes contradictory. No one principal is absolute and can be applied in all cases.
Buffet "Rule number 1 is never lose money."
SmithOnStocks corollary. This is harder to do in the volatile world of biotechnology investing and has led me to formulate my asymmetric approach which can lead to tolerable risk while still leaving open considerable upside returns.
Buffett "Rule number 2 is don't forget rule number 1."
SmithOnStocks corollary. I have nothing to add.
Buffett "Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."
SmithOnStocks corollary. Try to avoid getting caught up in speculation, despair or momentum swings which are more frequent in biotechnology stocks than the market as a whole. Consensus opinion often creates tops and bottoms.
Buffett "Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac's talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, "I can calculate the movement of the stars, but not the madness of men." If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases."
SmithOnStocks corollary. It is very hard to make good returns by trading in and out. Great investments are those in which one is focused on the long term for reasons which turn out to be correct and one doesn't try to catch every pop and drop. It is hard to buy back a stock that you have sold so that stocks destined to be long term winners are often thrown out and never returned to.
Buffet "The stock market is a no-called-strike game. You don't have to swing at everything--you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'"
SmithOnStocks corollary. You can't catch all the great stocks, but just catching a few can be very rewarding. Or, you can't kiss all the pretty girls (guys) at a dance.
Buffett "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
SmithOnStocks corollary. Don't be unduly price sensitive. Good stocks always seem to look too expensive.
Buffett "Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."
SmithOnStocks corollary. I have nothing to add.
Buffett"You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ."
SmithOnStocks corollary. The smartest guy in the room may not be the best investor. If that were the case, I would probably be pumping gas in my home state of Indiana.
Buffett "After all, you only find out who is swimming naked when the tide goes out."
SmithOnStocks corollary In good times, investors may ignore the potential negatives that become all too apparent when exuberance dies down and reality sets in.
Buffett "When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever."
SmithOnStocks corollary. This strategy would have worked well with Amgen and Genentech. I don't think that I can necessarily find stocks like these, but I hope to help you find stocks that you can profitably hold for a very long time.
Buffett "The best thing that happens to us is when a great company gets into temporary trouble...We want to buy them when they're on the operating table."
SmithOnStocks corollary. Biotechnology stocks are subject to great mood swings even when the fundamental outlook has not really changed. Be resolute if bad news overtakes a stock you hold if you believe that the long term story is in tack. This is also a time to be opportunistic. Great investments often are coincident with agonizing churning in your stomach and fear in your heart.
Buffett "Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497." (Editor's note: This was written a few years ago as the Dow is now at 15,901.)
SmithOnStocks corollary The stock market is a winner's game in which everyone can benefit from an ever rising market. It is not a zero sums game in which there is a loser for every winner. Being cynical and negative means that you are betting against the house.
Buffet "The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands."
SmithOnStocks corollary. Speculation didn't occur just recently with the Internet or housing bubble. Speculative bubbles seem to have occurred throughout history as evidenced by the tulip and South Sea bubbles.