What stocks to invest in
Pharma company VRX went from about $20 a share in 2010 to a peak of $263+ last year. It’s now trading at around $30.
To be clear, I don’t own the stock and never have. My only acquaintance with the company comes through the financial media and the occasional analyst report–plus a fast look at the stock price history before writing this.
On the surface, the stock screens well. Its ascent was mainly fueled by rapid earnings growth rather than by price-earnings multiple expansion. The company seems to have served up continuing positive earnings surprises in a highly visible industry, where such operating performance for large companies is rare. The only potential red flag I saw from historical data was the rapid build up of long-term debt resulting from VRX’s many acquisitions.
Among other places, I looked at an October 2015 report in Value Line. I was mostly interested in the past financial reporting data the service provides, but I also happened to glance down at the accompanying commentary, which urges investors to buy. The fall from $263 to $158 (the price on the date of the report) provided “a prime buying opportunity,”according to VL, with selling related to worries about drug price increases possibly “over done.” The stock also received VL’s highest rank for Timeliness back then, a rating derived from a statistical analysis of prior financial and trading data. My point is not to single out VL’s bad call, but rather to illustrate that there was no obvious sign in historical data of the trouble the stock price was signalling.
What I find worthy of note:
- The main drivers of the stock price seem to have been I’m-the-smartest-one-in-the-room-about-everything hedge fund managers, not traditional portfolio investors.
- Holders didn’t seem troubled by the fact that earnings growth was produced in considerable part by large price increases for mature drugs. That’s OK for things like art works or prime real estate. But history shows Americans have a visceral dislike for companies that make large profits from human misfortune, especially form health problems. Regulatory changes eliminating the profit “gouging” soon follow. In my view, then, the whole VRX concept was trouble waiting to happen. What veteran healthcare analyst wouldn’t know that?
- According to a number of media reports the chairman of VRX called select sell-side analysts after returning to the company after an illness last month, apparently to assure them that both he and the company were in robust health. What’s wrong with that? The purpose of Regulation FD, published by the SEC in 200, was to outlaw the selective dissemination of important company information (usually to favored brokerage house analysts) that most often occurred in phone calls like this. Even if no sensitive information was disclosed in the VRX calls, they give the appearance of impropriety. Why would any intelligent CEO do this? Especially since…
- Last Tuesday, the company had a public conference call in which it sharply revised down its earnings guidance for 2016. It also said it won’t be able to file its 2015 financials with the SEC on time, which will violate covenants on some of its debt. That breach will allow the affected lenders to begin a process that could lead to default on those obligations–possibly meaning a demand for immediate repayment of principal.
- If media reports are correct, the predominant hedge fund reaction to the rollover in VRX stock has been to buy more rather than reduce their exposure (see point 1 for the reason why).
There may be a time for deep value investors to come in and try to pick up the pieces. I don’t think we’re anywhere near that point, in time if nothing else, yet.
– What stocks to invest in