The Federal Government of these United States of America is partially closed down. Congress is divided against itself: the Republican-controlled House of Representatives can't agree with the Democrat-controller Senate on how to reopen.
More ominous, all pundits agree, is that the national debt will hit the debt ceiling sometime soon, with October 17, 2013 frequently given as an estimate. Since the federal government continues to run a budget deficit, its debt is increasing. The ceiling is $16.7 trillion.
The debt ceiling is artificial in the sense that it is legislated by Congress (and signed into law by the President). It can be raised or lowered by Congress. Those who believe the national debt is not a problem (or, misinterpreting Alexander Hamilton and John Maynard Keynes, is actually an asset) might want to just abolish the ceiling, or set at at $30 trillion and forget it for a couple of years.
There is a real debt ceiling, however. It does not have a definite number on it, but it is real enough.
Consider, as an analogy, propeller-driven airplanes. Each model of airplane has a ceiling, because air thins are you climb to higher elevations. The better designed and lighter the airplane and the more powerful its thrust (from the engine and propeller system), the higher the ceiling. But at some point every airplane stalls: its propeller cannot push enough air to give enough thrust to get it higher.
Likewise where the real debt ceiling is for the federal government of the United States depends on a variety of factors. For instance, if the government could raise more in taxes (by raising rates or because of an expanding economy), it would have a higher ceiling than if revenue from taxes fell.
If the federal government offers higher interest rates (which are set at auction), then investors should be willing to loan more money to it.
Investors, in fact, are the key actors. There are all sorts of investors who buy federal debt. Since the Great Recession began they have accepted very low rates of interest. More investors might buy federal debt if interest rates on the debt were higher.
But no matter how high interest rates go, there is still a ceiling. Even a loan shark charging interest (at perhaps 100% per year) to the federal government would stop loaning if it became clear that the loan could not be repaid. And who's going to break the legs of the federal government?
If the annual interest on the federal debt begins approach a high share of annual federal revenues, the federal government would go into a Death Spiral. Say the interest reached one-half, or 50% of annual revenues. Policy makers would have three basic choices. They could prioritize interest payments by cutting federal spending. But that would hurt the economy, resulting in lower tax collections the following year, plus there would be political fallout from the many Americans who depend on federal spending.
A second choice when interest on the debt reaches 50% of annual revenue would be to increase taxes so that spending could be maintained along with interest payments. The problem with that is that such taxes would have to be broadly based. The economy would go into a depression, lowering tax collections.
A combination of cutting spending and raising taxes might work today, but would just cause a depression if we wait until interest hits 50% of revenue.
A third choice is to simply let the debt balloon. But as the debt balloons, the interest would also balloon. Interest rates would have to go even higher. The necessity for defaulting on, or writing down, the debt would be obvious. The debt would quickly hit the real debt ceiling, but that would not stop the death spiral. If 50% of federal revenue were assigned to just pay the interest, it would not be enough. Bonds (federal debt) come due at intervals: the principle would have to be repaid. Just to replace the bonds would require higher interest rates, so the interest would soon consume 51% of revenue, then 52%, and on up to 100% of revenue.
Clearly the three choices above would lead to the end of the United States as we know it. A fourth possibility would be allowing inflation to reduce the real value of the debt. Long-term bond holders would just have to eat their losses. But even this would not likely work because it also would hurt the economy so badly that we would have a depression, which would be deflationary, defeating the purpose of allowing goods and services to inflate in dollar value.
The real debt ceiling is likely somewhere between where we are now and where the interest on the debt reaches 50% of federal revenue. Federal revenue in fiscal 2013 was budgeted at $2.9 trillion. 50% of that would be $1.45 trillion. If the average interest on federal debt rises to 5% (a conservative figure, but above what the feds paid during the recession), the debt ceiling in the scenario above would be 29 trillion dollars. Way above the current legal limit.
But if investors lose confidence in the federal government (which they should have by now) and the interest on the debt rose to an average of 10% (admittedly higher than it has been yet), the scenario of the death spiral would occur at $14.5 trillion dollars.
That is right. A death spiral is possible, if enough investors lose confidence, at below the current $16.7 trillion debt limit.
So where the real debt limit lies depends on where real investors, as a group, draw the line.
It would be interesting to ask a few people like Janet Yellen, Ben Bernanke, Lawrence Summers, Barack Obama, Jacob Lew and John Boehner exactly what they think the real debt limit is.
Even the GAO thinks "Debt held by the public at these high levels could limit the federal government's flexibility to address emerging issues and unforeseen challenges such as another economic downturn or large-scale natural disaster. Furthermore, in both the Baseline Extended and Alternative simulations, debt held by the public continues to grow as a share of GDP in the coming decades, indicating that the federal government remains on an unsustainable long-term fiscal path." [GAO Long Term Outlook]
I predict we are in for stormy fiscal weather. Today the government pays interest at a rate from practically zero on short term notes to 3.75% on 30 year bonds. I believe the Federal Reserve has gone to great lengths to keep interest rates low not just because that encourages an economic recovery, but because it puts off the day of reckoning on the real cost of the national debt.
The Republicans are right, we need to cut spending. But we have to cut spending in a way that minimized the hurt to both people and the economy. That means cutting subsidies to the rich, the upper middle class, and in particular military spending and foreign aid. But the Republicans want to cut payments for seniors and the poor.
The Democrats are right, we need more revenue, which means more taxes. We need a higher tax rate on people earning more than $50 million per year and on large inheritances. We need to close every loophole. We need to legalize and tax "street" drugs. But tax increases do result in less spending and less capital deployment, so they should be reasonable. And the Democrats, too, have been reluctant to cut military spending.
The American economy has been badly hurt by both parties and both branches of Congress and by the President these past few years. By protecting their turfs, including the Pentagon budget, they are weakening the long-term viability of the United States.
Both parties should agree to balance the budget in fiscal 2015 and start paying down the national debt in fiscal 2016. The pain will be shared by everyone, but to the extent it can be targeted by law, it should be dished out to those who have benefited most from the American economy.
Showing posts with label investors. Show all posts
Showing posts with label investors. Show all posts
Wednesday, October 9, 2013
Saturday, August 17, 2013
Inovio Gone Wild
Inovio Pharmaceuticals (INO) released Q2 results on August 9, 2013, and you can read my notes here: Inovio Results Q2 2013.
Because Inovio had been an under $1 stock until a few months ago, and then spiked to $3.03 on August 6, and because I had already invested in INO over a year ago, I thought it would be a good time to write an article for Seeking Alpha explaining my understanding of the company.
Here it is: Inovio's Price Spike and the Future of DNA Vaccines
The funny thing is, the article got quite long, and in the end I did not reference the Q2 results. That is okay, because the Q2 results don't tell you whether any vaccine in the INO pipeline is going to eventually get data good enough for FDA approval. Which is the crucial issue for start-up biotechnology companies like Inovio.
I tried to show what I think if the proper way for investors to think about startups and therapies that are in clinical trials, or even preclinical. Most analysts want to reduce everything to a "buy, hold, or sell" paradigm. But with healthcare pipelines no one really knows what the result of a clinical trial will be. IF we knew, why conduct the trial? And since nobody knows (including Wall Street sell-side analysts and hedge fund managers), the sensible approach is probability based and statistical. Bets should be spread out over a variety of companies that have a good probability of a high return on investment, with the expectation that some will have failed therapies. You have to make up for your losses with your gains.
If you have not learned basic probability and statistics (that's all you need), stay away from biotech therapy pipelines (or let someone manage your money who does. I do not manage other people's money, and I don't trust anyone to manage mine. Call me quirky.)
In particular, avoid stocks where the investment community, usually driven by sell-side analysts at major banks, has fully priced in victory. If FDA approval is priced into market capitalization, there is no reason to buy a stock (but your broker will suggest you do it anyway). What those of us who manage our own accounts want is companies where the market cap does not take into account the probable outcome. My usual examples of this for the past 5 years were BIIB, GILD, CELG, and ONXX, all of which had pipelines that were undervalued by the street. I continue to own all 4 of these stocks because while I think their current prices do predict a healthy 2014 in each case, I think the rest of the decade is not priced in.
But what I want to continue to search for, when I have time, is stocks like INO that still have a long way to go.
Keep Diversified!
Because Inovio had been an under $1 stock until a few months ago, and then spiked to $3.03 on August 6, and because I had already invested in INO over a year ago, I thought it would be a good time to write an article for Seeking Alpha explaining my understanding of the company.
Here it is: Inovio's Price Spike and the Future of DNA Vaccines
The funny thing is, the article got quite long, and in the end I did not reference the Q2 results. That is okay, because the Q2 results don't tell you whether any vaccine in the INO pipeline is going to eventually get data good enough for FDA approval. Which is the crucial issue for start-up biotechnology companies like Inovio.
I tried to show what I think if the proper way for investors to think about startups and therapies that are in clinical trials, or even preclinical. Most analysts want to reduce everything to a "buy, hold, or sell" paradigm. But with healthcare pipelines no one really knows what the result of a clinical trial will be. IF we knew, why conduct the trial? And since nobody knows (including Wall Street sell-side analysts and hedge fund managers), the sensible approach is probability based and statistical. Bets should be spread out over a variety of companies that have a good probability of a high return on investment, with the expectation that some will have failed therapies. You have to make up for your losses with your gains.
If you have not learned basic probability and statistics (that's all you need), stay away from biotech therapy pipelines (or let someone manage your money who does. I do not manage other people's money, and I don't trust anyone to manage mine. Call me quirky.)
In particular, avoid stocks where the investment community, usually driven by sell-side analysts at major banks, has fully priced in victory. If FDA approval is priced into market capitalization, there is no reason to buy a stock (but your broker will suggest you do it anyway). What those of us who manage our own accounts want is companies where the market cap does not take into account the probable outcome. My usual examples of this for the past 5 years were BIIB, GILD, CELG, and ONXX, all of which had pipelines that were undervalued by the street. I continue to own all 4 of these stocks because while I think their current prices do predict a healthy 2014 in each case, I think the rest of the decade is not priced in.
But what I want to continue to search for, when I have time, is stocks like INO that still have a long way to go.
Keep Diversified!
Tuesday, August 2, 2011
Plenty of Stimulus
I do not like the details of the debt ceiling deal signed into law by President Barack Obama today. I'll mention my reasons later. What I want to point out to investors and decision makers is that there is still plentiful stimulus in the new economic plan. Let's call it the new Two Year Plan.
The federal government, for the remainder of 2011 and 2012, is still going to create a lot of debt, which strangely is the same as creating a lot of money. Tax revenues will still be less than expenditures by over 2 trillion dollars in the next two years, unless the economy starts growing a lot faster.
Note that the Federal Reserve is keeping the interest rates it charges member banks near zero. That, in a normal recession, would be very stimulating in and of itself.
So why is the economy not growing faster?
People want simple, one variable solutions [we need more government spending, or we need less government spending, or deregulation, or ...] but in fact we are looking at a complex, multiple-variable problem.
If all those variables could be wrapped into one, I would say they relate to lack of confidence. There are many indicators of lack of confidence. One is the historically low price-to-earnings ratio in the stock market versus the historically low interest rates in the bond market. It is pretty easy to make 2 to 10 times as much return on your capital (or savings, if you prefer to think like a consumer) in the stock market today as in the bond market. Take fear out of the equation and funds would flow from bonds to stocks. Stocks would go up, and interest paid on bonds would climb as well. All investors would feel wealthier (except maybe those who were heavily in long-term bonds), and would spend more freely. That would help revive the consumer segment of the economy.
But that is easier said than done. The bond holders are the same people, in their tens of millions, who sold their stocks in 2008, at the bottom of the market, and effectively traded them for bonds. They are a fearful lot, easily stampeded.
We see a lack of confidence in bank lending practices. We see it in deferred purchasing of houses. The demand for housing is huge; interest rates and house prices are both low. But fear holds people pack.
The fear is not irrational, it is simply not analyzed. Bad things happened to a lot of people starting in 2007. Everyone who has a job today knows someone, maybe many people, who lost their jobs, homes, and even families. Almost everyone wants to minimize risk, even if that means substantially diminishing long-term opportunities (like buying houses and stocks cheap).
Sadly, the business men and women of America are hiding with the frightened steers rather than boldly leading us out of the recession. Every CEO wants the other CEOs to hire first, increasing demand, so that it will be safer to hire. Some even continue to lay off employees when they are running profitable companies, like Cisco's John Chambers, because they are not able to inspire investors with visions of future profits. Once a proud leader, John has become a harried, frightened little rabbit of a CEO.
U.S. executives, and their political mouth pieces, complain about taxes and regulations and high labor costs in the U.S. What, business was supposed to be easy? I agree that there are unnecessary regulations, but they are not what is stopping business expansion. Second rate CEOs are stopping business expansion. We still have some hard-charging leaders who can build up businesses (look at the biotechnology sector), but most contemporary CEO's are too effete to get their hands dirty doing real work.
The fact is the business climate in the U.S. and internationally is quite good now. Is anyone besides me embarrassed that a bunch of Communists in China are kicking our collective, free-market behinds? Do we want to have to admit that all our post-World War II free-market individualist posturing was not based on our outstanding individual capabilities, but on the fact that in World War II all of our competitors factories were bombed out of commission? China, at the end of World War II, had an economy they would have been ashamed of in the Middle Ages. They did not get to where they are now by slacking and refusing to deal with challenges.
What don't I like about the debt ceiling deal? I don't like the bloated military and homeland security budget, which we simply cannot afford. But mainly I don't like the fact that they could have come to the exact same decision a month ago. Congress and President Obama, Republicans and Tea Party and Democrats, basically killed economic expansion in the month of July.
The President, Congress, and other national leaders need to focus on restoring confidence. We need to reassure people that have jobs that they will keep them, and those that are looking that their search will end soon. We need for people to feel they can buy a home or replace some old appliance. We need to show the old American can-do business spirit of innovation. We also need to cooperate with each other to find solutions. We need to expand the pie, not fight over the crumbs.
There is plenty of stimulus. There is plenty of money being created. It needs to go into productive uses, not into the federal bond market.
The federal government, for the remainder of 2011 and 2012, is still going to create a lot of debt, which strangely is the same as creating a lot of money. Tax revenues will still be less than expenditures by over 2 trillion dollars in the next two years, unless the economy starts growing a lot faster.
Note that the Federal Reserve is keeping the interest rates it charges member banks near zero. That, in a normal recession, would be very stimulating in and of itself.
So why is the economy not growing faster?
People want simple, one variable solutions [we need more government spending, or we need less government spending, or deregulation, or ...] but in fact we are looking at a complex, multiple-variable problem.
If all those variables could be wrapped into one, I would say they relate to lack of confidence. There are many indicators of lack of confidence. One is the historically low price-to-earnings ratio in the stock market versus the historically low interest rates in the bond market. It is pretty easy to make 2 to 10 times as much return on your capital (or savings, if you prefer to think like a consumer) in the stock market today as in the bond market. Take fear out of the equation and funds would flow from bonds to stocks. Stocks would go up, and interest paid on bonds would climb as well. All investors would feel wealthier (except maybe those who were heavily in long-term bonds), and would spend more freely. That would help revive the consumer segment of the economy.
But that is easier said than done. The bond holders are the same people, in their tens of millions, who sold their stocks in 2008, at the bottom of the market, and effectively traded them for bonds. They are a fearful lot, easily stampeded.
We see a lack of confidence in bank lending practices. We see it in deferred purchasing of houses. The demand for housing is huge; interest rates and house prices are both low. But fear holds people pack.
The fear is not irrational, it is simply not analyzed. Bad things happened to a lot of people starting in 2007. Everyone who has a job today knows someone, maybe many people, who lost their jobs, homes, and even families. Almost everyone wants to minimize risk, even if that means substantially diminishing long-term opportunities (like buying houses and stocks cheap).
Sadly, the business men and women of America are hiding with the frightened steers rather than boldly leading us out of the recession. Every CEO wants the other CEOs to hire first, increasing demand, so that it will be safer to hire. Some even continue to lay off employees when they are running profitable companies, like Cisco's John Chambers, because they are not able to inspire investors with visions of future profits. Once a proud leader, John has become a harried, frightened little rabbit of a CEO.
U.S. executives, and their political mouth pieces, complain about taxes and regulations and high labor costs in the U.S. What, business was supposed to be easy? I agree that there are unnecessary regulations, but they are not what is stopping business expansion. Second rate CEOs are stopping business expansion. We still have some hard-charging leaders who can build up businesses (look at the biotechnology sector), but most contemporary CEO's are too effete to get their hands dirty doing real work.
The fact is the business climate in the U.S. and internationally is quite good now. Is anyone besides me embarrassed that a bunch of Communists in China are kicking our collective, free-market behinds? Do we want to have to admit that all our post-World War II free-market individualist posturing was not based on our outstanding individual capabilities, but on the fact that in World War II all of our competitors factories were bombed out of commission? China, at the end of World War II, had an economy they would have been ashamed of in the Middle Ages. They did not get to where they are now by slacking and refusing to deal with challenges.
What don't I like about the debt ceiling deal? I don't like the bloated military and homeland security budget, which we simply cannot afford. But mainly I don't like the fact that they could have come to the exact same decision a month ago. Congress and President Obama, Republicans and Tea Party and Democrats, basically killed economic expansion in the month of July.
The President, Congress, and other national leaders need to focus on restoring confidence. We need to reassure people that have jobs that they will keep them, and those that are looking that their search will end soon. We need for people to feel they can buy a home or replace some old appliance. We need to show the old American can-do business spirit of innovation. We also need to cooperate with each other to find solutions. We need to expand the pie, not fight over the crumbs.
There is plenty of stimulus. There is plenty of money being created. It needs to go into productive uses, not into the federal bond market.
Friday, June 3, 2011
AMD Fusion Upside
AMD (Advanced Micro Devices) recently revealed that it has been unable to meet the demand for its first Fusion processors. They call these APUs, for Advanced Processing Units, to indicate that each chip includes both a CPU and a GPU (graphics processing unit). Introduced in late 2010, the first APU variety was designed to bring low cost, high quality graphic capabilities to inexpensive notebook computers. Computer makers (HP, Lenovo, Sony, etc.) embraced these first Fusion chips as a big improvement on the Atom chip from Intel, famous for underwhelming netbooks (sub-standard but very portable notebooks).
Does that mean the sun is finally rising on AMD investors (that includes me)? Intel remains not only holding most market share, but dominating the most profitable segments of the market, including chips for server computers. On the other hand Intel has its own problems, pressed from below by ARM architecture based chips in smartphones and tablets, while failing to be able to deliver the graphic quality consumers now expect. To make a workable business or consumer computer manufacturers need to add an AMD Radeon or NVIDIA GPU to the system.
Intel itself is not exactly the darling of Wall Street anymore. Today Intel is trading at 10 times last year's non-GAAP earnings per share. No tech bubble there. AMD is trading at 8.5 times last year's EPS. Intel is wading in cash; AMD has a substantial amount of debt. If you wanted to buy a computer processor manufacturing company, Intel would be the more obvious choice.
To break out of its trading range AMD, at the very least, would have to start generating substantially more earnings than it has lately. What are the chances of that, when the sector itself appears to be in trouble, and Intel has a tradition of crushing AMD whenever Intel's market share starts to slip?
It really does come down to Fusion. Intel is scared of Fusion, so it is using considerable resources to catch up in graphics technology. Intel is now paying NVIDIA to use its intellectual property, which probably includes graphics designs. That should start to show up in Intel chips in 2012. My guesstimate is that by 2013 Intel will have closed the graphics gap. So AMD's future profits, and the value of its stock, highly depends on how much market share it can pick up in 2011 and 2012, and at what kind of profit margins.
It came as a surprise to me, and probably to everyone, that AMD became supply-constrained in Q1. I think the problem is that the first Fusion chips were on the 40 nm process, which is where most graphics chips are at this year. Both NVIDIA and AMD reported supply constraints at 40 nm in early 2010. AMD failed to anticipate demand for its new chips, and so did not book enough capacity in advance. AMD now contracts for fabrication of its chips, whereas Intel has its own fabs. On the April 21 AMD analyst call for Q1 2011, AMD executives talked about insuring future fabrication capacity, so that must be about the Fusion shortfall.
Right now AMD is about to launch its second round of Fusion processors, which will be more powerful, but also will require more power. So they will be for higher-end notebooks and for desktop CPUs. The will be on the more-advanced 33 nm process. That may have its own issues, but it won't run into the 40 nm roadblock. Later this year AMD will also introduce its Bulldozer CPUs, which are not part of Fusion (they don't have graphics processing on the die).
The upside for AMD investors depends on continued support from manufacturers (HP, Dell, Lenovo, etc.) and from retailers like Best Buy. The near-universal sentiment now is that consumers get more for their money with AMD based computer systems, particularly when it comes to graphics capabilities. Thus AMD should pick up market share this year in the sub-$1000 categories of notebook and desktop computers.
One commonly told story is that consumers are moving to tablets, so sales of PCs and notebook computers are about to come to a grinding halt. The actual evidence for that is scant. In the U.S., prior to the introduction of tablet computers (they've been around for nearly a decade, but did not become popular until Apple marketed a more attractive, if less powerful, version), everyone pretty much had at least one computer, either a desktop or a notebook, maybe a netbook. Most moderate to heavy users had a PC at work and a desktop and either a notebook or netbook for personal use. As the new thing, tablets are going to sell, and with budgets tight, they are going to cause purchases of notebooks and desktops to be delayed. But most tablet computer users have found they are not really a replacement for their more powerful cousins. So, the question becomes: what do they upgrade next? Are they going to get an even newer tablet, or are they going to refresh the old desktop or notebook computer?
You know what the gadget guys will have. A good, reliable, high-performance desktop, a good notebook computer for working away from home, a tablet to be cool and consume video, and a smartphone.
AMD is not going to compete in the smartphone space, but their Fusion chips are beginning to appear in Windows-based tablets. Their stand-alone graphics chips are now used by Apple for its desktop computers.
Also, this is a global market. The same low-cost high-graphics capability that appeals to U.S. consumers will appeal even more to first-time PC buyers in India, China, Brazil, and developing countries.
A recovery of market share in the server GPU market would also benefit AMD, but I'll leave that topic to a later story.
Any reasonable investor not already holding AMD should probably take a show-me the market share and EPS gains attitude. On the other hand, there is a good chance that 2011 will be a year when those of us who already hold AMD will see the upside of Fusion. Maybe as early as the report on Q2, if production was ramped for the new Fusion products.
See also:AMD home page
Tuesday, November 30, 2010
Springtime Economy Cold Spells
Divorced from nature, human minds often make simplistic assumptions about the future. The most common one is that today's trend is tomorrow's trend. That is the kind of thinking that creates financial bubbles.
Think about the season of spring. I know that can be difficult as we enter winter in the northern hemisphere, but it is just a metaphor anyway. So think, perhaps, of last spring. It does not come on all at once, despite being driven by the steady progression of the sun to longer days. There are cycles of cold and warmth.
We may speak of winter returning, but we know as the weeks pass the snow and ice will melt and we will get more frequent warm spells. We even change our definition of warmth. In late winter a warm day may include a night time freeze. In late spring a warm day may miss freezing by 20 degrees.
Development of spring into summer is uneven across geographies. Once state may be having a late winter storm while another has a summer-like day.
So too it is with macroeconomics. We have been through a fairly severe global recession, but it is already summer in China and India. Within the American economy one sector may advance while another remains flat or even declines a bit. In particular in 2010 we saw reduced government spending, but despite that the economy did not collapse. The economy warmed up a fair amount in 2010 despite dire predictions of catastrophe in Europe and a double dip in the U.S. And despite a still-weak housing construction sector.
There are all sorts of signs that the economy is in recovery. That may not be any consolation to those frozen in an unemployed or even homeless status, but it important for investors to see the overall picture accurately. A lot of people panicked and lost a lot of their savings in 2008 when they sold stocks at the bottom of the market. If they had held on, they would be in far better shape now.
Another economic winter will come, to be sure, but we have not even hit late spring yet, much less summer. The way to prepare for winter is to lay aside your winter supplies during the summer, rather than acting as if summer will never end.
2011 should be a good year for the American economy. That does not mean it will be a good year for every single person, or for every business, or every business sector. But hopefully we have, collectively, learned something about the wise use of credit and the need to produce real goods and services in a global economy. Bidding up the prices of things that already exist, be they Beanie Babies or houses, is not a real economic advance.
Stocks can be bid up too high too, but that was not the problem during the latest bubble. Stock prices should reflect the earnings potential of the companies involved. The more profitable companies are, the higher their stock prices should be. The main danger is getting talked into investing in companies that are not profitable, or are obviously going to become unprofitable as the economy changes.
Spring is in the air. Wise investors can hear the birds singing and the wheat and corn sprouting in the fields. If you don't sow, you can't harvest. People who are 100% in bonds should be seriously thinking of rebalancing their portfolios to include stocks again. The value of low interest bonds tends to melt away during the hot days of summer. Better to own CDs at a credit union than bonds once interest rates start rising. And beware the current line of bull about investing in foreign stock funds. Many nations have even less regulation and transparency that the United States. A good rule for investing is don't do it if you don't know what you are doing. There is plenty of risk involved even when you know what you are doing.
See also: Virtuous Economic Cycle Components [September 15, 2010]
Think about the season of spring. I know that can be difficult as we enter winter in the northern hemisphere, but it is just a metaphor anyway. So think, perhaps, of last spring. It does not come on all at once, despite being driven by the steady progression of the sun to longer days. There are cycles of cold and warmth.
We may speak of winter returning, but we know as the weeks pass the snow and ice will melt and we will get more frequent warm spells. We even change our definition of warmth. In late winter a warm day may include a night time freeze. In late spring a warm day may miss freezing by 20 degrees.
Development of spring into summer is uneven across geographies. Once state may be having a late winter storm while another has a summer-like day.
So too it is with macroeconomics. We have been through a fairly severe global recession, but it is already summer in China and India. Within the American economy one sector may advance while another remains flat or even declines a bit. In particular in 2010 we saw reduced government spending, but despite that the economy did not collapse. The economy warmed up a fair amount in 2010 despite dire predictions of catastrophe in Europe and a double dip in the U.S. And despite a still-weak housing construction sector.
There are all sorts of signs that the economy is in recovery. That may not be any consolation to those frozen in an unemployed or even homeless status, but it important for investors to see the overall picture accurately. A lot of people panicked and lost a lot of their savings in 2008 when they sold stocks at the bottom of the market. If they had held on, they would be in far better shape now.
Another economic winter will come, to be sure, but we have not even hit late spring yet, much less summer. The way to prepare for winter is to lay aside your winter supplies during the summer, rather than acting as if summer will never end.
2011 should be a good year for the American economy. That does not mean it will be a good year for every single person, or for every business, or every business sector. But hopefully we have, collectively, learned something about the wise use of credit and the need to produce real goods and services in a global economy. Bidding up the prices of things that already exist, be they Beanie Babies or houses, is not a real economic advance.
Stocks can be bid up too high too, but that was not the problem during the latest bubble. Stock prices should reflect the earnings potential of the companies involved. The more profitable companies are, the higher their stock prices should be. The main danger is getting talked into investing in companies that are not profitable, or are obviously going to become unprofitable as the economy changes.
Spring is in the air. Wise investors can hear the birds singing and the wheat and corn sprouting in the fields. If you don't sow, you can't harvest. People who are 100% in bonds should be seriously thinking of rebalancing their portfolios to include stocks again. The value of low interest bonds tends to melt away during the hot days of summer. Better to own CDs at a credit union than bonds once interest rates start rising. And beware the current line of bull about investing in foreign stock funds. Many nations have even less regulation and transparency that the United States. A good rule for investing is don't do it if you don't know what you are doing. There is plenty of risk involved even when you know what you are doing.
See also: Virtuous Economic Cycle Components [September 15, 2010]
Wednesday, September 22, 2010
Biogen Idec, the MS market, and Gilenya
Multiple sclerosis (MS) is a disabling and eventually deadly disease in which the human immune system attacks otherwise healthy nervous tissues. It affects about 2.5 million people worldwide including about 400,000 in the U.S., where prevalence is much higher than the global average. Today the FDA announced it had approved Novartis's Gilenya (fingolimod) as the first oral treatment for MS.
Biogen Idec stock has sold at depressed prices for several years now, despite the company's high level of profitability. The long-term, main reason for this is that Tysabri (natalizumab), which is the most effective MS drug ever developed, has the unfortunate effect of allowing a virus that is resident (and normally harmless) in many people's brains to become active, causing progressive multifocal leukoencephalopathy (PML), which can be fatal. All Tysabri patients are now monitored for symptoms of PML, but there is no doubt that many doctors and patients have refused the drug because of the side effect.
The problem with Tysabri, and with MS drugs in general, is that the cure involves suppressing the immune system. Therapies less effective than Tysabri are not as good at suppressing the immune system; Biogen's Avonex is an example. Other partially effective treatments for MS include corticosteroids, interferons (Avonex is one), Copaxone (which requires once-a-day injection), and Novantrone (which has harmful side-effects on the heart, and is somewhat of a last resort).
Gilenya acts by keeping lymphocytes in lymph nodes, so that they do not attack the central nervous system in MS. But that means that, like all immune system suppressors, it is likely to occasionally prevent the immune system from doing its job of controlling infections. It seems to have a side effect of inducing basal-cell carcinomas as well as opportunistic infections. "Cases of serious eye problems (macular edema) have occurred in patients taking the drug and an ophthalmologic evaluation is recommended." In trials it reduces relapses of MS by over 50%, which is a good number, but not as effective as Tysabri's.
So what Gilenya has going for it is that it can be administered orally. Tysabri is given by infusion, a less convenient method to be sure.
Meanwhile Biogen Idec has an oral MS medication, BG-12, in Phase III trials. Data should be out in 2011. BG-12 Phase II data was reported in terms of decreasing lesions caused by MS, also stating that relapse rates decreased, and frequency of infection was low. It should be noted, however, that short-term studies have typically underestimated the effects of long-term immune system repression on infection rates and mortality.
Since BG-12 has a novel mechanism of action, which "defends against oxidative-stress induced neuronal death, protects the blood-brain barrier, and supports maintenance of myelin integrity," if it has good phase III results and is approved by the FDA, there will be reason for prescribing it apart from its oral administration.
For investors, in short today's reaction to the FDA approval of Gilenya is overblown. Biogen sells at a very attractive P/E. Biogen Idec's strong pipeline of potential therapies promise to expand its overall market share over time.
At this point, however, I would suggest that given its profitability, Biogen Idec should pay a dividend. I own Biogen (BIIB) stock and believe paying a dividend would compensate for the low P/E ratio while waiting to see if I am right that revenues and profits will indeed continue to ramp nicely in 2011 and 2012.
See also my Biogen Idec Analyst Conference Call summaries.
William P. Meyers
Biogen Idec stock has sold at depressed prices for several years now, despite the company's high level of profitability. The long-term, main reason for this is that Tysabri (natalizumab), which is the most effective MS drug ever developed, has the unfortunate effect of allowing a virus that is resident (and normally harmless) in many people's brains to become active, causing progressive multifocal leukoencephalopathy (PML), which can be fatal. All Tysabri patients are now monitored for symptoms of PML, but there is no doubt that many doctors and patients have refused the drug because of the side effect.
The problem with Tysabri, and with MS drugs in general, is that the cure involves suppressing the immune system. Therapies less effective than Tysabri are not as good at suppressing the immune system; Biogen's Avonex is an example. Other partially effective treatments for MS include corticosteroids, interferons (Avonex is one), Copaxone (which requires once-a-day injection), and Novantrone (which has harmful side-effects on the heart, and is somewhat of a last resort).
Gilenya acts by keeping lymphocytes in lymph nodes, so that they do not attack the central nervous system in MS. But that means that, like all immune system suppressors, it is likely to occasionally prevent the immune system from doing its job of controlling infections. It seems to have a side effect of inducing basal-cell carcinomas as well as opportunistic infections. "Cases of serious eye problems (macular edema) have occurred in patients taking the drug and an ophthalmologic evaluation is recommended." In trials it reduces relapses of MS by over 50%, which is a good number, but not as effective as Tysabri's.
So what Gilenya has going for it is that it can be administered orally. Tysabri is given by infusion, a less convenient method to be sure.
Meanwhile Biogen Idec has an oral MS medication, BG-12, in Phase III trials. Data should be out in 2011. BG-12 Phase II data was reported in terms of decreasing lesions caused by MS, also stating that relapse rates decreased, and frequency of infection was low. It should be noted, however, that short-term studies have typically underestimated the effects of long-term immune system repression on infection rates and mortality.
Since BG-12 has a novel mechanism of action, which "defends against oxidative-stress induced neuronal death, protects the blood-brain barrier, and supports maintenance of myelin integrity," if it has good phase III results and is approved by the FDA, there will be reason for prescribing it apart from its oral administration.
For investors, in short today's reaction to the FDA approval of Gilenya is overblown. Biogen sells at a very attractive P/E. Biogen Idec's strong pipeline of potential therapies promise to expand its overall market share over time.
At this point, however, I would suggest that given its profitability, Biogen Idec should pay a dividend. I own Biogen (BIIB) stock and believe paying a dividend would compensate for the low P/E ratio while waiting to see if I am right that revenues and profits will indeed continue to ramp nicely in 2011 and 2012.
See also my Biogen Idec Analyst Conference Call summaries.
William P. Meyers
Wednesday, September 15, 2010
Virtuous Economic Cycle Components
After a severe recession there are going to be some very damaged sectors of an economy. They don't all spring back at once. Some lead, some lag the general upturn. While past upturns offer patterns that may be repeated, the economy is a complex beast, so it is not surprising if details differ in each cycle.
In 2009 the stock market indexes hit bottom, then had a good climb. In 2010 so far we have been up and down a number of times, ending around flat today after a good start to September. Not knowing history, one might theorize that the stock market should have a damping effect on economic cycles (not dipping as deeply, not rising as quickly). This would be because a common theory is that stocks are about future value. So stock prices should take into account long-term returns, which should in turn take into account the cycles of growth and recession that characterize capitalist economies.
But, in just one for-instance, in early 2009 the stock market averages dipped far more, as a percentage, than GDP. Same in the 2001 crash. But in 2001 the fall came mainly because leading up to 2000 investors forgot to take into account that the profitability of the companies' would drop when a recession took hold. The Federal Reserve failed in its duty to dampen a bubble because big egos mistakenly believed, and told the mass of investors, that cycles were over, to be replaced by more-or-less steady economic growth.
At its bottom in 2009 the stock market was suffering from the opposite delusion: that the economy would never recover. I would argue that in 2007, with the exception of the banking sector, most stocks had in fact priced in the entire economic cycle. The commodity sector had not, and of course housing prices and loans against housing had not. Many people lost all or much of their retirement investments not because they had invested badly, but because they panicked and sold near the bottom.
The big price swings in stocks are because they are auction markets. They are efficient at matching buyers with sellers, but they overprice and underprice securities when there is a deficit of one party or the other.
Today housing, both used housing stock and the building of new housing, is still weak. There are still some pockets of vacuum where people pretend there are loans that will be repaid; there is still turbulence. But the economy can suffer a fair amount of turbulence without crashing.
Demand continues to pick up despite the fact that we are no longer seeing net stimulus from the government sector. Some sectors of the economy are showing strength, notably agriculture and export-oriented industry. Those who are employed are much more confident of keeping their jobs than they were a year ago. They also, on the whole, have paid down their debts and are in a much better position to shop more without getting themselves into trouble. So I would expect that as the employed spend more retailers will be encouraged to do more hiring.
That is the thing about the virtuous part of the cycle. More hiring means more retail sales, and less of a drain on government for unemployment compensation and the like. More retail sales means more manufacturing. And in turn more hiring.
In 2011 we can expect people who have huddled together in houses and apartments to save money to begin to feel secure enough to venture out on their own. That means more rental income (if not increased rents or housing prices, at first) and, after all these many years, the absorption of excess housing stock.
All these processes take time. The stock market is an important part of this cycle. People spend more when their stocks are up. Those who own stocks represent a disproportionate part of the spending equation. If investors are so cautious that stocks take another dive, that will slow down the natural upswing. If the market moves up smartly in the near term, that will accelerate the recovery.
In 2009 the stock market indexes hit bottom, then had a good climb. In 2010 so far we have been up and down a number of times, ending around flat today after a good start to September. Not knowing history, one might theorize that the stock market should have a damping effect on economic cycles (not dipping as deeply, not rising as quickly). This would be because a common theory is that stocks are about future value. So stock prices should take into account long-term returns, which should in turn take into account the cycles of growth and recession that characterize capitalist economies.
But, in just one for-instance, in early 2009 the stock market averages dipped far more, as a percentage, than GDP. Same in the 2001 crash. But in 2001 the fall came mainly because leading up to 2000 investors forgot to take into account that the profitability of the companies' would drop when a recession took hold. The Federal Reserve failed in its duty to dampen a bubble because big egos mistakenly believed, and told the mass of investors, that cycles were over, to be replaced by more-or-less steady economic growth.
At its bottom in 2009 the stock market was suffering from the opposite delusion: that the economy would never recover. I would argue that in 2007, with the exception of the banking sector, most stocks had in fact priced in the entire economic cycle. The commodity sector had not, and of course housing prices and loans against housing had not. Many people lost all or much of their retirement investments not because they had invested badly, but because they panicked and sold near the bottom.
The big price swings in stocks are because they are auction markets. They are efficient at matching buyers with sellers, but they overprice and underprice securities when there is a deficit of one party or the other.
Today housing, both used housing stock and the building of new housing, is still weak. There are still some pockets of vacuum where people pretend there are loans that will be repaid; there is still turbulence. But the economy can suffer a fair amount of turbulence without crashing.
Demand continues to pick up despite the fact that we are no longer seeing net stimulus from the government sector. Some sectors of the economy are showing strength, notably agriculture and export-oriented industry. Those who are employed are much more confident of keeping their jobs than they were a year ago. They also, on the whole, have paid down their debts and are in a much better position to shop more without getting themselves into trouble. So I would expect that as the employed spend more retailers will be encouraged to do more hiring.
That is the thing about the virtuous part of the cycle. More hiring means more retail sales, and less of a drain on government for unemployment compensation and the like. More retail sales means more manufacturing. And in turn more hiring.
In 2011 we can expect people who have huddled together in houses and apartments to save money to begin to feel secure enough to venture out on their own. That means more rental income (if not increased rents or housing prices, at first) and, after all these many years, the absorption of excess housing stock.
All these processes take time. The stock market is an important part of this cycle. People spend more when their stocks are up. Those who own stocks represent a disproportionate part of the spending equation. If investors are so cautious that stocks take another dive, that will slow down the natural upswing. If the market moves up smartly in the near term, that will accelerate the recovery.
Wednesday, May 26, 2010
Seeing the Value in Stocks Today
There are a lot of measuring sticks that can be used to value people, goods, services, and investments. Using the wrong measure, even when that measure is used accurately, can lead to poor or even disastrous decisions. I have read a lot of bad financial advice lately, but most of it would not be bad all the time. The ability to match up general guidelines to specific situations is key to investment success.
A lot of pundits are saying "stocks are overvalued." Even if true, this statement is so general as to border on useless advice to most investors. Even in a bull market, there are individual stocks that are undervalued; even in a bear market, there are individual stocks that are overvalued. If you want to know if stocks, on average, are overvalued, you need to choose your measuring stick. The most commonly used is the price-to-earnings ratio, abreviated P/E or PE. Generally, low PEs are better, as they indicate more earnings you get for each dollar you spend on a stock.
But PEs don't exist in isolation, whether you are looking at market averages or a PE for an individual stock. Two companies can have stocks that are at differing PEs, but both be of equal intrinsic value. For instance, company A might seem like a twin of company B except that A has a healthy cash balance and B is deeply in debt. So even though they both produce the same earnings (aka net income), we would expect A to be more highly valued, and it would have the higher PE. That does not mean company B is bad, it just takes the debt into account when valuing the stock.
Companies C and D might also be twins, if you just look at their accounting numbers for the latest quarter. But company C is a technology innovator and is growing its revenues and profits, while company D is essentially static. So company C should have a higher PE. If it did not, investors who owned D and looked at C would sell D and buy C until an equilibrium is reached.
There are, of course, other variables that affect a company's PE, including subjective factors.
Now think of stocks in general, or in aggregate. It does not make sense to say something like "between 1932 and 2009 the average stock PE was X" but today the average stock PE is X+ something, so stocks are too high.
To value stocks in general, you would need to know how much cash and debt there is on the balance books of the companies we are aggregating. You need to know whether the bundle of companies is growing revenues and profits. You need to know where you are in an economic cycle, which no one seems to be very sure of. You would need to predict the rate of inflation, and compare stocks to alternative investments like real estate, bonds, cash, and CDs.
You also need to look at how the PE itself is created. I like GAAP numbers because they take everything into account, but someone trying to sell you stock almost always uses prettier non-GAAP numbers. The stated PE is usually reasonably objective (once you choose between GAAP and non-GAAP) because it is based on published reports for the last four quarters. But where the company will be in a year is important to investors, and that is guesswork.
What if PEs for the market at a whole are above some historical average, but in six months, if prices remain the same, they will be below the historical average because profits are ramping?
Profits were horrible in Q1 and Q2 2009. Do we measure a company's worth by its profits in those quarters, or by a backward-looking year that includes those quarters? Certainly we should take those quarters into account, but they should not be allowed too much bias.
In this market, where people feel they were lied to in the last bull market (because they were) and are struggling just to keep their homes, only a few stocks are likely to be truly overvalued at any time. From my point of view hundreds, if not thousands, of stocks are so undervalued that I wish I could buy them all. I would buy the whole companies at today's prices, if I were in that league of investor.
Instead I manage my small portfolio as best I can. It includes some speculative stocks of companies that will leap in value if they can ever get to profitability, like Hansen Medical and Dot Hill. But the core of my holdings are in companies like Marvell Technology Group, Gilead, and Biogen. They have large cash balances, are growing, and yet have low PEs. There are hundreds of stocks that have all these attributes right now. And there are good companies paying higher dividends on their stocks than you can get from CDs or Treasury bonds.
Know what you are doing. Do your own research. And ...
Keep Diversified!
A lot of pundits are saying "stocks are overvalued." Even if true, this statement is so general as to border on useless advice to most investors. Even in a bull market, there are individual stocks that are undervalued; even in a bear market, there are individual stocks that are overvalued. If you want to know if stocks, on average, are overvalued, you need to choose your measuring stick. The most commonly used is the price-to-earnings ratio, abreviated P/E or PE. Generally, low PEs are better, as they indicate more earnings you get for each dollar you spend on a stock.
But PEs don't exist in isolation, whether you are looking at market averages or a PE for an individual stock. Two companies can have stocks that are at differing PEs, but both be of equal intrinsic value. For instance, company A might seem like a twin of company B except that A has a healthy cash balance and B is deeply in debt. So even though they both produce the same earnings (aka net income), we would expect A to be more highly valued, and it would have the higher PE. That does not mean company B is bad, it just takes the debt into account when valuing the stock.
Companies C and D might also be twins, if you just look at their accounting numbers for the latest quarter. But company C is a technology innovator and is growing its revenues and profits, while company D is essentially static. So company C should have a higher PE. If it did not, investors who owned D and looked at C would sell D and buy C until an equilibrium is reached.
There are, of course, other variables that affect a company's PE, including subjective factors.
Now think of stocks in general, or in aggregate. It does not make sense to say something like "between 1932 and 2009 the average stock PE was X" but today the average stock PE is X+ something, so stocks are too high.
To value stocks in general, you would need to know how much cash and debt there is on the balance books of the companies we are aggregating. You need to know whether the bundle of companies is growing revenues and profits. You need to know where you are in an economic cycle, which no one seems to be very sure of. You would need to predict the rate of inflation, and compare stocks to alternative investments like real estate, bonds, cash, and CDs.
You also need to look at how the PE itself is created. I like GAAP numbers because they take everything into account, but someone trying to sell you stock almost always uses prettier non-GAAP numbers. The stated PE is usually reasonably objective (once you choose between GAAP and non-GAAP) because it is based on published reports for the last four quarters. But where the company will be in a year is important to investors, and that is guesswork.
What if PEs for the market at a whole are above some historical average, but in six months, if prices remain the same, they will be below the historical average because profits are ramping?
Profits were horrible in Q1 and Q2 2009. Do we measure a company's worth by its profits in those quarters, or by a backward-looking year that includes those quarters? Certainly we should take those quarters into account, but they should not be allowed too much bias.
In this market, where people feel they were lied to in the last bull market (because they were) and are struggling just to keep their homes, only a few stocks are likely to be truly overvalued at any time. From my point of view hundreds, if not thousands, of stocks are so undervalued that I wish I could buy them all. I would buy the whole companies at today's prices, if I were in that league of investor.
Instead I manage my small portfolio as best I can. It includes some speculative stocks of companies that will leap in value if they can ever get to profitability, like Hansen Medical and Dot Hill. But the core of my holdings are in companies like Marvell Technology Group, Gilead, and Biogen. They have large cash balances, are growing, and yet have low PEs. There are hundreds of stocks that have all these attributes right now. And there are good companies paying higher dividends on their stocks than you can get from CDs or Treasury bonds.
Know what you are doing. Do your own research. And ...
Keep Diversified!
Sunday, April 4, 2010
Bonds, Danger! Bonds, Danger!
I have touched on this topic before, but this is a good time to repeat my warning.
Bonds are usually thought of as safe. That is the wrong way to think of bonds right now (except for very short term bonds, say less than 2 years).
Bonds are the most dangerous financial investment you can own today. It does not matter whether they are U.S. treasury bonds, corporate bonds, or municipal bonds. The general danger does not lie in possible defaults, though of course individual bond issuers could go bankrupt and default.
Many investors, including individuals whose investments come from 401k and IRA accounts, had little or no experience with bonds prior to the Panic of 2008. Typically, after taking significant losses in the stock market or in real-estate investments, individuals and sometimes even large entities like pension funds wanted some place to park their cash. They were advised to buy bonds. This advice was self-serving by brokers, who could take fees for buying the bonds, but would not get fees if they left the money in the form of cash.
Under normal circumstances bonds play a ballast-like role in investment portfolios. Normally they do not fluctuate in value as much as stocks and produced a decent long-term rate of return that is higher than you would get on a CD of similar term. Returns for a given length of time vary mainly according to the perceived risk of the entity doing the issuing, so the U.S. Government pays the lowest interest, solid corporations a middling interest rate, and weaker entities pay "junk bond" interest rates. Short term rates are usually much lower than long term rates, but the differential is affected by the outlook for inflation.
Underlying interest rates are typically set by the Federal Reserve, but even the Fed cannot fight market forces forever. Right now real short to medium term interest rates on Federal debt don't even cover the loss of principal from the effects of inflation. The Federal Reserve is keeping interest rates artificially low to help revive the economy and to keep the interest on the federal debt a relatively low percentage of the federal budget.
But the danger in bonds is not in the low interest rates they are paying today. It is not even in the fact that people who were 100% in bonds in 2009 lost out on a major stock market rally. And what I am going to point to should not be a problem with balanced portfolios that include appropriate ratios of bonds with stocks or other investments.
But if you are 100% in bonds, you had best get out, or largely out, while you still can, before everyone realizes what is happening.
Bond interest rates are highly likely to rise. And they may rise rapidly once they start rising, regardless of how the Fed tries to fight market forces.
If your broker put you in bonds or bond funds, you might think that higher interest rates is a good thing. After all, you have been getting about 2% interest (maybe 3.5% if you are all in long term bonds) for a couple of years now; that seems more like being a chump than an investor. Surely it is better for bonds to be at say, 6%? Isn't that a pretty nice return on a safe investment, as opposed to chewing your nails about stocks or real estate or commodity prices?
The problem comes when you (or your broker, or bond fund manager) tries to sell your 3% bonds to buy 6% bonds (note how I have made the math easy!). Say both bonds terminate the same year, say 2020. Who wants to buy a bond that is going to make 3% interest for another 20 years when they could buy a new bond at 6%? Only one kind of trader: the kind that will get a deep discount on the bond. Like say a 30% discount. Because for a thousand dollar bond, principal plus (simple) interest at 6% for ten years givens you a total of $1600. Pay a thousand, get $600. But your old bond will pay only $300 interest over the remaining ten years. So to be worth the same amount of money, the buyer would only pay $700 for the bond itself (getting, in the end, $1000 principal and $300 interest for $700; making the same $600). You, who foolishly were in 100% long bonds, suddenly have lost 30% of your life savings just because interest rates have gone up.
And they will go up, unless we are hit by a global Depression that makes the Panic of 2008 look like an ice-cream party. The indebtedness of the Federal government keeps ballooning, and that is, so far, while paying low interest rates. You know those penalty interest rates credit card companies like to charge their most unfortunate, weakest customers? That is the direction we are probably headed in, if taxes are not increased and expenses reduced to quickly balance the budget. The economy is reviving, but that won't increase government tax revenues fast enough to make up for reckless spending and ballooning debt payments.
No one in their right mind should be loaning the United States of America money at under 10% these days, to compensate for the default and inflation risk. Now that you have thought about it, I'm sure that you as a rational individual would not do that. But tens of millions of Americans depend on mutual funds, brokers, and financial advisers to manage their investments, and they are being told to keep their money in federal bond funds. It is bad advice brought to you by the same pack of jackals and fools who brought you the Panic of 2008. It is up to you to stop playing the fool and to warn your friends.
Most publicly traded American corporations are much sounder than the federal government right now, and so should be able to issue bonds at less than the government rates. But when federal bond rates go up, they become comparisons for all bonds. That will likely force corporate bond rates up as well, causing their principal value to weaken. So if you can get out of corporate bonds before the crisis, do it.
Bonds are usually thought of as safe. That is the wrong way to think of bonds right now (except for very short term bonds, say less than 2 years).
Bonds are the most dangerous financial investment you can own today. It does not matter whether they are U.S. treasury bonds, corporate bonds, or municipal bonds. The general danger does not lie in possible defaults, though of course individual bond issuers could go bankrupt and default.
Many investors, including individuals whose investments come from 401k and IRA accounts, had little or no experience with bonds prior to the Panic of 2008. Typically, after taking significant losses in the stock market or in real-estate investments, individuals and sometimes even large entities like pension funds wanted some place to park their cash. They were advised to buy bonds. This advice was self-serving by brokers, who could take fees for buying the bonds, but would not get fees if they left the money in the form of cash.
Under normal circumstances bonds play a ballast-like role in investment portfolios. Normally they do not fluctuate in value as much as stocks and produced a decent long-term rate of return that is higher than you would get on a CD of similar term. Returns for a given length of time vary mainly according to the perceived risk of the entity doing the issuing, so the U.S. Government pays the lowest interest, solid corporations a middling interest rate, and weaker entities pay "junk bond" interest rates. Short term rates are usually much lower than long term rates, but the differential is affected by the outlook for inflation.
Underlying interest rates are typically set by the Federal Reserve, but even the Fed cannot fight market forces forever. Right now real short to medium term interest rates on Federal debt don't even cover the loss of principal from the effects of inflation. The Federal Reserve is keeping interest rates artificially low to help revive the economy and to keep the interest on the federal debt a relatively low percentage of the federal budget.
But the danger in bonds is not in the low interest rates they are paying today. It is not even in the fact that people who were 100% in bonds in 2009 lost out on a major stock market rally. And what I am going to point to should not be a problem with balanced portfolios that include appropriate ratios of bonds with stocks or other investments.
But if you are 100% in bonds, you had best get out, or largely out, while you still can, before everyone realizes what is happening.
Bond interest rates are highly likely to rise. And they may rise rapidly once they start rising, regardless of how the Fed tries to fight market forces.
If your broker put you in bonds or bond funds, you might think that higher interest rates is a good thing. After all, you have been getting about 2% interest (maybe 3.5% if you are all in long term bonds) for a couple of years now; that seems more like being a chump than an investor. Surely it is better for bonds to be at say, 6%? Isn't that a pretty nice return on a safe investment, as opposed to chewing your nails about stocks or real estate or commodity prices?
The problem comes when you (or your broker, or bond fund manager) tries to sell your 3% bonds to buy 6% bonds (note how I have made the math easy!). Say both bonds terminate the same year, say 2020. Who wants to buy a bond that is going to make 3% interest for another 20 years when they could buy a new bond at 6%? Only one kind of trader: the kind that will get a deep discount on the bond. Like say a 30% discount. Because for a thousand dollar bond, principal plus (simple) interest at 6% for ten years givens you a total of $1600. Pay a thousand, get $600. But your old bond will pay only $300 interest over the remaining ten years. So to be worth the same amount of money, the buyer would only pay $700 for the bond itself (getting, in the end, $1000 principal and $300 interest for $700; making the same $600). You, who foolishly were in 100% long bonds, suddenly have lost 30% of your life savings just because interest rates have gone up.
And they will go up, unless we are hit by a global Depression that makes the Panic of 2008 look like an ice-cream party. The indebtedness of the Federal government keeps ballooning, and that is, so far, while paying low interest rates. You know those penalty interest rates credit card companies like to charge their most unfortunate, weakest customers? That is the direction we are probably headed in, if taxes are not increased and expenses reduced to quickly balance the budget. The economy is reviving, but that won't increase government tax revenues fast enough to make up for reckless spending and ballooning debt payments.
No one in their right mind should be loaning the United States of America money at under 10% these days, to compensate for the default and inflation risk. Now that you have thought about it, I'm sure that you as a rational individual would not do that. But tens of millions of Americans depend on mutual funds, brokers, and financial advisers to manage their investments, and they are being told to keep their money in federal bond funds. It is bad advice brought to you by the same pack of jackals and fools who brought you the Panic of 2008. It is up to you to stop playing the fool and to warn your friends.
Most publicly traded American corporations are much sounder than the federal government right now, and so should be able to issue bonds at less than the government rates. But when federal bond rates go up, they become comparisons for all bonds. That will likely force corporate bond rates up as well, causing their principal value to weaken. So if you can get out of corporate bonds before the crisis, do it.
Wednesday, June 3, 2009
Cisco Systems Joins Dow Industrial Average
Cisco is becoming part of the Dow Jones Industrial Average. As far as I know it is remaining in the NASDAQ 100 for a time as well. The NASDAQ 100 is my favorite hunting grounds for new investments. Cisco's promotion to the DOW illustrates why.
I have been posting summaries of Cisco's analyst conferences since November of 2006. Now I'm going to stop. It is not that Cisco has become a poor investment. I expect Cisco to continue to be a technology leader, and a growth stock, for the foreseeable future. But I can only cover a limited number of stocks. Cisco is very well covered by the news media and other analysts, and as a DOW stock will receive even more attention. I watched it because it gave insight into Internet connectivity trends. I also often considered buying the stock, but it never became enough of a bargain for me, compared to the stocks I bought.
Note that Cisco is entering the Dow at one of the worst moments in its history. In the most recently reported quarter, revenues were $8.2 billion, down 10% sequentially from $9.1 billion and down 17% from $9.8 billion year-earlier. Net income was $1.3 billion, down 13% sequentially from $1.5 billion, and down 24% from $1.8 billion year-earlier. EPS (earnings per share) were $0.23, down 12% sequentially from $0.26, and down 21% from $0.29 year-earlier.
Yet that is not bad compared to most of the technology industry. Given the state of the economy, it is remarkable that Cisco is selling that much equipment. It is mostly capital equipment, which tends to stall during downturns.
In early 2008, we now know with hindsight, Cisco's management was overly optimistic. They thought their broad array of products, global reach, and tendency to rapid growth would mean a recession would just cut into their growth rate. They did not admit to revenue declines until they actually occurred. That said my impression is that management is very honest with investors. They just underestimated the severity of the crisis that was building. I did that too.
As of last report, the demand for Cisco products was stabilizing. Given the need to bringing high speed broadband Internet to more of the world, and the increased use of the Internet for video, I think Cisco's prospects are bright.
There is not much left of the old industrial economy in the DOW. But I think there is still hope for manufacturing in the United States, if Americans get back to working hard and being satisfied with global pay levels. U.S. executives are even more overpaid than their European and Asian counterparts. According to standard market economic theories, that has to change, or American manufacturing will continue to fail.
I have been posting summaries of Cisco's analyst conferences since November of 2006. Now I'm going to stop. It is not that Cisco has become a poor investment. I expect Cisco to continue to be a technology leader, and a growth stock, for the foreseeable future. But I can only cover a limited number of stocks. Cisco is very well covered by the news media and other analysts, and as a DOW stock will receive even more attention. I watched it because it gave insight into Internet connectivity trends. I also often considered buying the stock, but it never became enough of a bargain for me, compared to the stocks I bought.
Note that Cisco is entering the Dow at one of the worst moments in its history. In the most recently reported quarter, revenues were $8.2 billion, down 10% sequentially from $9.1 billion and down 17% from $9.8 billion year-earlier. Net income was $1.3 billion, down 13% sequentially from $1.5 billion, and down 24% from $1.8 billion year-earlier. EPS (earnings per share) were $0.23, down 12% sequentially from $0.26, and down 21% from $0.29 year-earlier.
Yet that is not bad compared to most of the technology industry. Given the state of the economy, it is remarkable that Cisco is selling that much equipment. It is mostly capital equipment, which tends to stall during downturns.
In early 2008, we now know with hindsight, Cisco's management was overly optimistic. They thought their broad array of products, global reach, and tendency to rapid growth would mean a recession would just cut into their growth rate. They did not admit to revenue declines until they actually occurred. That said my impression is that management is very honest with investors. They just underestimated the severity of the crisis that was building. I did that too.
As of last report, the demand for Cisco products was stabilizing. Given the need to bringing high speed broadband Internet to more of the world, and the increased use of the Internet for video, I think Cisco's prospects are bright.
There is not much left of the old industrial economy in the DOW. But I think there is still hope for manufacturing in the United States, if Americans get back to working hard and being satisfied with global pay levels. U.S. executives are even more overpaid than their European and Asian counterparts. According to standard market economic theories, that has to change, or American manufacturing will continue to fail.
Thursday, May 21, 2009
Akamai Future Trends
Does Akamai have what it takes to make long term investors happy even after this recession ends and stock prices go to normal levels relative to fundamentals?
I am not sure. Akamai accelerates the Internet. They are good at it. They have a technological edge over all rivals. I would not be surprised if the size of Akamai, measured in terms of revenues or net income, is ten times today's ten years from now. On the other hand, we are going into uncharted terrain where you can't just draw a line on a graph and assume it will rise linearly or exponentially forever.
It does seem likely that Internet usage, measured in bits delivered, will continue to grow for the foreseeable future. But it might not. Much of the growth in the past ten years has been driven by the shift to bandwidth intensive applications. Sending a text email over the net involves shifting a few bits. Sending a small image as an attachment with the email can increase the number of bits by an order or more of magnitude. Audio and high quality still pictures require another order of magnitude or more of data transfer. The short videos made for tiny windows of a few years ago upped the stakes yet again.
The number of people using the Internet, however, no longer climbs at the dizzying rate of the 1990s. Most of the growth in new customers now comes in developing countries. In some nations, like the U.S., the failure to provide a comprehensive broadband infrastructure has also put a damper on Internet data transfer growth. You can't do much with video when you access the net with a dial-up modem connection. But to the extent people start expecting DVD quality or HD quality video over the Internet, we still have a long way to go in increased bandwidth.
Your guess is as good as the experts. My guess is that it will be at least five to ten years before Internet growth rates really flatten out.
So if Akamai maintains market share, we can look forward to a good decade. What are the chances Akamai will gain or lose market share?
It is easy to see Akamai gaining market share. They simply accelerate Internet delivery faster than any other company can. Right now. You don't want to run a major merchant web site right now without Akamai's help.
Akamai is also starting to have better penetration outside the U.S. That alone could be a major growth driver.
On the other hand, plenty of would-be competitors exist. Most are losing money, but some may reach the inflection point where they have enough customers to make money. The really big companies that are well-situated to compete with Akamai are Cisco and Oracle. Cisco, in particular, probably possesses the skills to do well in the Web acceleration business. But Cisco has a lot of other fires burning right now. Akamai is thriving on specialization.
So I would judge competition to be a threat, but not enough of a threat to bet against Akamai staying on top for at least the next few years.
How did Akamai do in the latest quarter?
Revenue was $210.4 million, down 1% sequentially from $212.6 million and up 12% from $187.0 million year-earlier.
Net income was $37.1 million, down 9% sequentially from $40.5 million, but up slightly from $36.9 million year-earlier.
EPS (earnings per share) were $0.20, down 9% sequentially from $0.22, and flat from $0.20 year-earlier.
Cash from operations was $90.5 million, up 3% y/y. The company held $848.5 million in cash and equivalents at the end of the quarter. There are $200 million in convertible notes outstanding. Capital expenditures were $25.0 million.
See my Akamai Analyst Conference Summary of April 29, 2009 for a higher level of detail.
Akamai Investor Relations page
My Akamai main page
I am not sure. Akamai accelerates the Internet. They are good at it. They have a technological edge over all rivals. I would not be surprised if the size of Akamai, measured in terms of revenues or net income, is ten times today's ten years from now. On the other hand, we are going into uncharted terrain where you can't just draw a line on a graph and assume it will rise linearly or exponentially forever.
It does seem likely that Internet usage, measured in bits delivered, will continue to grow for the foreseeable future. But it might not. Much of the growth in the past ten years has been driven by the shift to bandwidth intensive applications. Sending a text email over the net involves shifting a few bits. Sending a small image as an attachment with the email can increase the number of bits by an order or more of magnitude. Audio and high quality still pictures require another order of magnitude or more of data transfer. The short videos made for tiny windows of a few years ago upped the stakes yet again.
The number of people using the Internet, however, no longer climbs at the dizzying rate of the 1990s. Most of the growth in new customers now comes in developing countries. In some nations, like the U.S., the failure to provide a comprehensive broadband infrastructure has also put a damper on Internet data transfer growth. You can't do much with video when you access the net with a dial-up modem connection. But to the extent people start expecting DVD quality or HD quality video over the Internet, we still have a long way to go in increased bandwidth.
Your guess is as good as the experts. My guess is that it will be at least five to ten years before Internet growth rates really flatten out.
So if Akamai maintains market share, we can look forward to a good decade. What are the chances Akamai will gain or lose market share?
It is easy to see Akamai gaining market share. They simply accelerate Internet delivery faster than any other company can. Right now. You don't want to run a major merchant web site right now without Akamai's help.
Akamai is also starting to have better penetration outside the U.S. That alone could be a major growth driver.
On the other hand, plenty of would-be competitors exist. Most are losing money, but some may reach the inflection point where they have enough customers to make money. The really big companies that are well-situated to compete with Akamai are Cisco and Oracle. Cisco, in particular, probably possesses the skills to do well in the Web acceleration business. But Cisco has a lot of other fires burning right now. Akamai is thriving on specialization.
So I would judge competition to be a threat, but not enough of a threat to bet against Akamai staying on top for at least the next few years.
How did Akamai do in the latest quarter?
Revenue was $210.4 million, down 1% sequentially from $212.6 million and up 12% from $187.0 million year-earlier.
Net income was $37.1 million, down 9% sequentially from $40.5 million, but up slightly from $36.9 million year-earlier.
EPS (earnings per share) were $0.20, down 9% sequentially from $0.22, and flat from $0.20 year-earlier.
Cash from operations was $90.5 million, up 3% y/y. The company held $848.5 million in cash and equivalents at the end of the quarter. There are $200 million in convertible notes outstanding. Capital expenditures were $25.0 million.
See my Akamai Analyst Conference Summary of April 29, 2009 for a higher level of detail.
Akamai Investor Relations page
My Akamai main page
Thursday, March 12, 2009
Have We Hit Bottom Yet?
What every investor wants to know: have we hit bottom yet? Business people want to know that too. Should we lay off more people, buy that new ERP software, or cut that dividend?
Smart people will use a cover your bets approach. We have already seen a number of worst-case scenarios starting in 2007.
Typically, in the post-Depression recessions, the stock market averages started recovering before the rest of the economy. Stock markets are believed to be forward looking. But that may not be the case this time.
There are a number of differences between this recession and prior post-New Deal down cycles, and a number of similarities. Sorting them out may not tell them if we are at a bottom yet, but they can help us understand how to get our footing once there is a bottom.
Fortunately, many major corporations were cash rich going into this downturn, and are well-positioned to weather anything thrown at them short of the collapse of civilization. Some are taking advantage of their cash positions to buy assets cheap, which is what I believe investors with cash coming in should be doing right now.
Most people who are losing their jobs are getting unemployment compensation. More than any other New Deal reform, this tends to put the brakes on recessions.
The big obvious problems, of course, are banks and housing. The Federal Reserve System was set up to deal with banking credit cycle issues. Unfortunately the Fed is run by people, and in particular it was run for a long time by a certifiable idiot, Alan Greenspan. Alan drank the Free Markets are God kool-aid. If free markets were not sometimes a problem, we would not have needed the Federal Reserve in the first place. Free markets are not magic. They have their own mechanics, and don't care too much about human beings.
It is a tribute to the resiliancy of capitalism, the safety valves and safety nets of socialism that have been grafted onto it in the United States, and the good sense of most business persons that the crew of the likes of Alan Greenspan, Robert Rubin, Bill Clinton, George W. Bush, et al, actually did so little damage to our economy.
I am glad the American people, as a whole, started saving more money in 2008. Even though it hurt the holiday shopping season, even though it hurt the auction prices of some of my stocks. It was the right thing to do. Shopping on credit that has to be paid at high rates of interest is no way to run a family economic unit, and no way to run an economy. Lowered household debt as we go into 2010 will mean people will be paying less interest, and have more actual money of their own to shop with. I just hope we all remember this lesson.
Housing remains an interesting dilemma. As far as I can tell, there is no longer a surplus of housing in the U.S. as a whole, though some areas remain overbuilt, like the central California valley. If the banking system starts functioning in a healthy manner, surplus of houses for sale right now will shrink throughout 2009. In 2010 new home construction will become necessary in at least some areas. That in itself should get the economy back to normal.
But I don't feel the bottom under my feet yet. One more part of the down cycle has not really kicked in, and it could force us further out into the stormy seas. This is the bankruptcy cascade. Businesses can fall like houses of cards when this cycle starts. A business that seems solvent, with plenty of receivables to use to cover its payables, can be put in jeapardy if its receivables disappear in customer bankruptcies.
On the other hand, this is also a healthy, important part of business consolidation. Week, poorly managed businesses with insufficient profit margins or cash reserves get punished. Well-capitalized companies get a licking, for sure, but they can then pick up any paying customers of the losers and enter a new expansion cycle.
This is a stock pickers market. If you are in index funds, you are a fool. The only stocks worth buying now are those with large cash reserves built from profitable business practices. Those cash reserves stand for conservative management. They represent past profits, and they are the ticket to future profits.
Today Gilead (GILD) [I own Gilead stock] announced it will buy CV Therapeutics (CVTX). Gilead is your prototypical well-managed company. Even after it buys CV, it will have a huge cash balance. That's the way to do it.
Keep diversified!
Smart people will use a cover your bets approach. We have already seen a number of worst-case scenarios starting in 2007.
Typically, in the post-Depression recessions, the stock market averages started recovering before the rest of the economy. Stock markets are believed to be forward looking. But that may not be the case this time.
There are a number of differences between this recession and prior post-New Deal down cycles, and a number of similarities. Sorting them out may not tell them if we are at a bottom yet, but they can help us understand how to get our footing once there is a bottom.
Fortunately, many major corporations were cash rich going into this downturn, and are well-positioned to weather anything thrown at them short of the collapse of civilization. Some are taking advantage of their cash positions to buy assets cheap, which is what I believe investors with cash coming in should be doing right now.
Most people who are losing their jobs are getting unemployment compensation. More than any other New Deal reform, this tends to put the brakes on recessions.
The big obvious problems, of course, are banks and housing. The Federal Reserve System was set up to deal with banking credit cycle issues. Unfortunately the Fed is run by people, and in particular it was run for a long time by a certifiable idiot, Alan Greenspan. Alan drank the Free Markets are God kool-aid. If free markets were not sometimes a problem, we would not have needed the Federal Reserve in the first place. Free markets are not magic. They have their own mechanics, and don't care too much about human beings.
It is a tribute to the resiliancy of capitalism, the safety valves and safety nets of socialism that have been grafted onto it in the United States, and the good sense of most business persons that the crew of the likes of Alan Greenspan, Robert Rubin, Bill Clinton, George W. Bush, et al, actually did so little damage to our economy.
I am glad the American people, as a whole, started saving more money in 2008. Even though it hurt the holiday shopping season, even though it hurt the auction prices of some of my stocks. It was the right thing to do. Shopping on credit that has to be paid at high rates of interest is no way to run a family economic unit, and no way to run an economy. Lowered household debt as we go into 2010 will mean people will be paying less interest, and have more actual money of their own to shop with. I just hope we all remember this lesson.
Housing remains an interesting dilemma. As far as I can tell, there is no longer a surplus of housing in the U.S. as a whole, though some areas remain overbuilt, like the central California valley. If the banking system starts functioning in a healthy manner, surplus of houses for sale right now will shrink throughout 2009. In 2010 new home construction will become necessary in at least some areas. That in itself should get the economy back to normal.
But I don't feel the bottom under my feet yet. One more part of the down cycle has not really kicked in, and it could force us further out into the stormy seas. This is the bankruptcy cascade. Businesses can fall like houses of cards when this cycle starts. A business that seems solvent, with plenty of receivables to use to cover its payables, can be put in jeapardy if its receivables disappear in customer bankruptcies.
On the other hand, this is also a healthy, important part of business consolidation. Week, poorly managed businesses with insufficient profit margins or cash reserves get punished. Well-capitalized companies get a licking, for sure, but they can then pick up any paying customers of the losers and enter a new expansion cycle.
This is a stock pickers market. If you are in index funds, you are a fool. The only stocks worth buying now are those with large cash reserves built from profitable business practices. Those cash reserves stand for conservative management. They represent past profits, and they are the ticket to future profits.
Today Gilead (GILD) [I own Gilead stock] announced it will buy CV Therapeutics (CVTX). Gilead is your prototypical well-managed company. Even after it buys CV, it will have a huge cash balance. That's the way to do it.
Keep diversified!
Friday, January 9, 2009
Hansen Medical (HNSN) Coverage Begins
I am now covering Hansen Medical (HNSN) at this blog and at OpenIcon. That means that I plan to write a summary of Hansen's quarterly analyst conferences. Hansen announced preliminary results for its fourth quarter (Q4) of 2008 today, but that gives no where near the insight of the full presentation to analysts that should take place later this month.
Hansen makes robotic catheters. That interests me because it combines my interest in robotics (and machine intelligence) with with my interest in biotechnology. Also, I am going to start covering Intuitive Surgical (ISRG) [See also my Intuitive Surgical analyst conferences page], which has a great business model and has made some investors very happy. I don't own stock in either Intuitive or Hansen, but if their prices remain in the bargain basement and I like what I learn from further scrutiny, I am likely to pick them up at some point this year. That won't effect the stock price either way because I currently play with very small sums of money.
Hansen's rapid growth did not continue in Q4, but they did not do badly either. They shipped 11 Sensei systems and revenues will be above $7 million. Given the financial turmoil in Q4, I think anything above zero shipments should give investors confidence in the long-term prospects of the company. Hansen's main difficulty is that it is losing money while trying to grow. At some point if margins do not improve on increased sales, money is going to have to come from outside. If it comes through a stock sale, that will hurt current investors. Borrowing money, if it is even possible, involves its own risks.
I'll know a lot more and hope to share my first Hansen Medical analyst conference summary with you soon.
Keep diversified!
Hansen makes robotic catheters. That interests me because it combines my interest in robotics (and machine intelligence) with with my interest in biotechnology. Also, I am going to start covering Intuitive Surgical (ISRG) [See also my Intuitive Surgical analyst conferences page], which has a great business model and has made some investors very happy. I don't own stock in either Intuitive or Hansen, but if their prices remain in the bargain basement and I like what I learn from further scrutiny, I am likely to pick them up at some point this year. That won't effect the stock price either way because I currently play with very small sums of money.
Hansen's rapid growth did not continue in Q4, but they did not do badly either. They shipped 11 Sensei systems and revenues will be above $7 million. Given the financial turmoil in Q4, I think anything above zero shipments should give investors confidence in the long-term prospects of the company. Hansen's main difficulty is that it is losing money while trying to grow. At some point if margins do not improve on increased sales, money is going to have to come from outside. If it comes through a stock sale, that will hurt current investors. Borrowing money, if it is even possible, involves its own risks.
I'll know a lot more and hope to share my first Hansen Medical analyst conference summary with you soon.
Keep diversified!
Tuesday, December 16, 2008
Anesiva's Good Adlea Results
I trashed Anesiva management for not keeping investors informed of its problems with manufacturing Zingo [See Anesiva (ANSV) Drops Zingo].
Yet I felt the market reaction to the discontinuance of Zingo was overdone. Why? Because the majority of the future value of the company was always in the potential of Adlea.
Adlea a simple, long-term painkiller that is dripped into surgical wounds. It appears to have no side affects and keeps pain down for weeks. It allows patients to cut back on their use of morphine. The FDA is reputed to be eager to have a non-addictive, surgical wound specific analgesic on the market.
Adlea has had a lot of clinical trials now, including Phase III trials. Overall it has done well, always showing pain reduction, but in some specific uses or test runs not quite hitting its endpoints. The latest test results [See Anesiva Adlea press release] met the endpoints for total knee replacement surgery.
Adlea's problem now is that they ran through their cash after they got FDA approval for Zingo. So they don't appear to have the cash required to get Adlea to market. They need a partner, because in this market you can't issue new stocks or bonds even if you have a blockbuster winner like Adlea sitting in your lap. Another possibility would be a buyout from a larger pharma company.
Sometimes other companies are willing to let a winner die on the vine, either to prevent competition or to pick it up even cheaper later. There's no telling how this would play out. Normally I'd say Anesiva (ANSV) is worth large multiples of its current market capitalization, but that depends on money coming from somewhere to get Adlea approved and marketed.
More:
My Anesiva page
www.anesiva.com
Keep Diversified!
Yet I felt the market reaction to the discontinuance of Zingo was overdone. Why? Because the majority of the future value of the company was always in the potential of Adlea.
Adlea a simple, long-term painkiller that is dripped into surgical wounds. It appears to have no side affects and keeps pain down for weeks. It allows patients to cut back on their use of morphine. The FDA is reputed to be eager to have a non-addictive, surgical wound specific analgesic on the market.
Adlea has had a lot of clinical trials now, including Phase III trials. Overall it has done well, always showing pain reduction, but in some specific uses or test runs not quite hitting its endpoints. The latest test results [See Anesiva Adlea press release] met the endpoints for total knee replacement surgery.
Adlea's problem now is that they ran through their cash after they got FDA approval for Zingo. So they don't appear to have the cash required to get Adlea to market. They need a partner, because in this market you can't issue new stocks or bonds even if you have a blockbuster winner like Adlea sitting in your lap. Another possibility would be a buyout from a larger pharma company.
Sometimes other companies are willing to let a winner die on the vine, either to prevent competition or to pick it up even cheaper later. There's no telling how this would play out. Normally I'd say Anesiva (ANSV) is worth large multiples of its current market capitalization, but that depends on money coming from somewhere to get Adlea approved and marketed.
More:
My Anesiva page
www.anesiva.com
Keep Diversified!
Friday, December 12, 2008
California Housing Dynamics
At this point I am largely discounting the Great Depression scenario. It is not impossible, but its probability has receded to the extent that I believe it is better to focus my analysis on less grim pictures.
I even doubt the recession will last into 2010. A lot of this has to do with housing.
Right now mortgage rates (standard 30 year rates) are moving towards 4.5% interest. Unless you already own a house, it is foolish to pass by what may be a once-in-a-lifetime opportunity. In California, in some areas, houses can be bought for less than they were priced at before the bubble began in 2002. Even desirable San Francisco neighborhoods are off their peaks. Many new and nearly new homes are available at bargain prices as well.
Why are people not buying, at least not in sufficient numbers yet to prevent price declines? Fear in an auction market. Few people want to buy an asset with a declining trend line. Most people think in straight lines, not in cycles. They don't want to guess at turning points.
We know there will be a turning point, in California and elsewhere. Once housing prices start back up, pent up demand from immigrants, the houseless, and the braver sort of speculators will turn into actual buying. At first this will drive houses to what would be their equilibrium price in a non-auction system, basically somewhere between the cost of building or replacing the house and the rental equivalent.
Getting to the turning point will require stages. We have already completed, or nearly completed, the first stage: a dramatic drop in house sale prices to below their equilibrium value.
With 4.5% mortgages we will get the next tranche of buyers, those who can put rationality ahead of their fears. They are going to get serious bargains. They will worry that houses or interest rates will go lower, but that will be offset by the desire to get into the house they want, before choices get narrowed.
Meanwhile, the employment situation in the real estate industry will improve slightly. Not too many houses are being built, and less are being started, in California right now. Brokers and realtors will get some wind in their sales from the first tranche of buyers, and the most optimistic builders will start making plans just in case their inventories start to sell.
When prices clearly stop going down, a lot of fence sitters will jump in. At first this will absorb inventory rather than raise prices significantly, but again it will result in increased employment in real estate, and maybe even at building supply and furnishings retailers.
We will know we are on to the third tranche of buyers when people start seeing their favorite potential homes picked off by someone else. The word will be out: buy now while interest rates are low, prices are low, and there are a lot of choices.
Then prices will start rising. You know the rest of the cycle. Builders will have lagged with new home starts, so by the time inventory is getting to normal levels they'll be in a panic to start up again. Lots of people will get hired. For a while the porridge will be just right, and then, lessons of the past forgotten, the porridge will get too hot.
But I am not thinking of getting into speculating in housing. While the leverage advantages are good there, I think stocks are even more undervalued than homes right now. I already own a home, but I don't own anywhere near enough stocks or bonds (but it is a bad time to buy bonds) yet.
I even doubt the recession will last into 2010. A lot of this has to do with housing.
Right now mortgage rates (standard 30 year rates) are moving towards 4.5% interest. Unless you already own a house, it is foolish to pass by what may be a once-in-a-lifetime opportunity. In California, in some areas, houses can be bought for less than they were priced at before the bubble began in 2002. Even desirable San Francisco neighborhoods are off their peaks. Many new and nearly new homes are available at bargain prices as well.
Why are people not buying, at least not in sufficient numbers yet to prevent price declines? Fear in an auction market. Few people want to buy an asset with a declining trend line. Most people think in straight lines, not in cycles. They don't want to guess at turning points.
We know there will be a turning point, in California and elsewhere. Once housing prices start back up, pent up demand from immigrants, the houseless, and the braver sort of speculators will turn into actual buying. At first this will drive houses to what would be their equilibrium price in a non-auction system, basically somewhere between the cost of building or replacing the house and the rental equivalent.
Getting to the turning point will require stages. We have already completed, or nearly completed, the first stage: a dramatic drop in house sale prices to below their equilibrium value.
With 4.5% mortgages we will get the next tranche of buyers, those who can put rationality ahead of their fears. They are going to get serious bargains. They will worry that houses or interest rates will go lower, but that will be offset by the desire to get into the house they want, before choices get narrowed.
Meanwhile, the employment situation in the real estate industry will improve slightly. Not too many houses are being built, and less are being started, in California right now. Brokers and realtors will get some wind in their sales from the first tranche of buyers, and the most optimistic builders will start making plans just in case their inventories start to sell.
When prices clearly stop going down, a lot of fence sitters will jump in. At first this will absorb inventory rather than raise prices significantly, but again it will result in increased employment in real estate, and maybe even at building supply and furnishings retailers.
We will know we are on to the third tranche of buyers when people start seeing their favorite potential homes picked off by someone else. The word will be out: buy now while interest rates are low, prices are low, and there are a lot of choices.
Then prices will start rising. You know the rest of the cycle. Builders will have lagged with new home starts, so by the time inventory is getting to normal levels they'll be in a panic to start up again. Lots of people will get hired. For a while the porridge will be just right, and then, lessons of the past forgotten, the porridge will get too hot.
It is a great time to move to California. I heard in 2005 people wanted to move here but could believe the housing prices. In some places today, in the central valley, houses are at midwestern prices.
But I am not thinking of getting into speculating in housing. While the leverage advantages are good there, I think stocks are even more undervalued than homes right now. I already own a home, but I don't own anywhere near enough stocks or bonds (but it is a bad time to buy bonds) yet.
Sunday, November 9, 2008
Rackable Systems Has Ice Cube Orders
Rackable Systems (RACK) has been talking about its ICE Cube containerized datacenter systems for over a year now. At their analyst conference on November 3, 2008, they announced that an indefinite amount of ICE Cubes will ship in Q4. My take is that if the orders are not cancelled, and if they ship early enough in Q4, Rackable may report revenues from the orders in Q4. This is great news for Rackable investors (which includes me).
We knew from the pre-announcement that Q3 results would be bad, and they were. Revenues were $65.3 million, down 14% sequentially from $76.0 million and down 25% from $87.2 million year-earlier.
On the other hand, even though net income was negative, it improved significantly due to tighter cost controls. Net income was a loss of $6.0 million, a sequential improvement on Q2 loss of $27.9 million, but worse than essentially $0 results year-earlier. EPS was negative $0.20, compared to negative $0.95 in Q2, and $0.00 year-earlier.
Rackable still has a lot of cash and equivalents, ended at $184.6 million, down sequentially from $198.1 million. Most of the reduction, according to management, was to produce the ICE Cube units that will ship this quarter.
Rackable was not able to sell its RapidScale storage division, so that will be written off as a loss. Instead it is partnering with NetApp for storage. You may recall how RapidScale was once lauded as a division that was going to give Rackable a competitive edge and good profit margins once it ramped up. Well, that does not mean closing it down now is not the right thing to do.
The NetApp partnership might work out to be more than it appears. Management says the NetApp people are introducing them to potential new clients. Since NetApp is probably confronted with occasional losses against vendors like HP and Dell that can provide both servers and storage, working with Rackable could prevent them from losing from sales. It is conceivable that the partnership could be quite beneficial for both parties, but I would not bet on it until I saw some actual revenues coming in. Rackable expects the NetApp partnership to start generating revenue in 2009.
They continue to lead with their high-quality, computationally intense, energy efficient technology. Their newest technology is called CloudRack. Obviously they are targeting the cloud computing market.
Rackable's stock is in the dumps, but then again they have not turned in a profitable quarter in some time. They have enough cash to survive a downturn, but so do their principal competitors. So Rackable, while promising, has to be rated as a risky tech stock.
For details on what management said on November 3, see my Summary of the Rackable Systems analyst conference for Q3 2008.
Keep Diversified!
More:
Rackable Systems
We knew from the pre-announcement that Q3 results would be bad, and they were. Revenues were $65.3 million, down 14% sequentially from $76.0 million and down 25% from $87.2 million year-earlier.
On the other hand, even though net income was negative, it improved significantly due to tighter cost controls. Net income was a loss of $6.0 million, a sequential improvement on Q2 loss of $27.9 million, but worse than essentially $0 results year-earlier. EPS was negative $0.20, compared to negative $0.95 in Q2, and $0.00 year-earlier.
Rackable still has a lot of cash and equivalents, ended at $184.6 million, down sequentially from $198.1 million. Most of the reduction, according to management, was to produce the ICE Cube units that will ship this quarter.
Rackable was not able to sell its RapidScale storage division, so that will be written off as a loss. Instead it is partnering with NetApp for storage. You may recall how RapidScale was once lauded as a division that was going to give Rackable a competitive edge and good profit margins once it ramped up. Well, that does not mean closing it down now is not the right thing to do.
The NetApp partnership might work out to be more than it appears. Management says the NetApp people are introducing them to potential new clients. Since NetApp is probably confronted with occasional losses against vendors like HP and Dell that can provide both servers and storage, working with Rackable could prevent them from losing from sales. It is conceivable that the partnership could be quite beneficial for both parties, but I would not bet on it until I saw some actual revenues coming in. Rackable expects the NetApp partnership to start generating revenue in 2009.
They continue to lead with their high-quality, computationally intense, energy efficient technology. Their newest technology is called CloudRack. Obviously they are targeting the cloud computing market.
Rackable's stock is in the dumps, but then again they have not turned in a profitable quarter in some time. They have enough cash to survive a downturn, but so do their principal competitors. So Rackable, while promising, has to be rated as a risky tech stock.
For details on what management said on November 3, see my Summary of the Rackable Systems analyst conference for Q3 2008.
Keep Diversified!
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Rackable Systems
Tuesday, October 21, 2008
Gilead (GILD) Thrives Despite Downturn
Investors who own good, or even great, companies right now are often feeling bad about their investments because stock prices are low even for these companies. As far as I can tell, while some low stock prices are needed to factor in the troubles of the economy, in the case of great companies this is purely due to liquidity issues. People who know they own valuable stocks that should be kept because of their current value and future potential are being "forced" to sell them to maintain their own liquidity. Also, money flows into the stock market on a comparison basis; it will tend to flow into the (perceived) best bargains of the moment.
Gilead Sciences (GILD) showed it is a great company for shareholders when it reported on its third quarter on October 16, 2008. It is one of the most successful biotechnology companies because it developed and sells great antiviral products that target HIV infections and hepatitis. These drugs are not dispensable; people who need them buy them even in economic downturns. In addition, Gilead's drugs continue to replace competitors' drugs in these spaces.
Q3 revenues tell the story pretty well. They were $1.37 billion, up up 7% sequentially from $1.28 billion in Q2 and up 29% from $1.06 billion year-earlier. Earnings per share (EPS) were $0.52, up 13% sequentially from $0.46 and up 24% from $0.42 year-earlier.
There is no need to worry about liquidity at Gilead. They are sitting on top of $3.26 billion in cash and equivalents. Operating cash flows were $555 million for the quarter.
See my Gilead (GILD) analyst conference summary for Q3 2008 for more details.
Fortunately, I am not overextended and am gradually adding to my portfolio. It almost feels like stealing. After years of watching hedge fund managers tell the world what hot shots they were when all they were doing was leveraging credit into ordinary investments, picking their pockets while they are down feels pretty good. You can almost correlate how much of a stock was owned by hedge funds by viewing its price percentage decline this last year.
I own Gilead as part of a long term strategy. My one suggested change for management would be that they start paying a dividend. I prefer that over stock-buy backs. Dividends allow me to choose to diversify, or to take income, without having to sell stocks and pay capital gains.
Biogen Idec reported some very impressive results today. You can get a good picture of the current state of the company at me Biogen Idec (BIIB) analyst conference summary for Q3 2008.
More data:
http://www.gilead.com/
Gilead Sciences (GILD) showed it is a great company for shareholders when it reported on its third quarter on October 16, 2008. It is one of the most successful biotechnology companies because it developed and sells great antiviral products that target HIV infections and hepatitis. These drugs are not dispensable; people who need them buy them even in economic downturns. In addition, Gilead's drugs continue to replace competitors' drugs in these spaces.
Q3 revenues tell the story pretty well. They were $1.37 billion, up up 7% sequentially from $1.28 billion in Q2 and up 29% from $1.06 billion year-earlier. Earnings per share (EPS) were $0.52, up 13% sequentially from $0.46 and up 24% from $0.42 year-earlier.
There is no need to worry about liquidity at Gilead. They are sitting on top of $3.26 billion in cash and equivalents. Operating cash flows were $555 million for the quarter.
See my Gilead (GILD) analyst conference summary for Q3 2008 for more details.
Fortunately, I am not overextended and am gradually adding to my portfolio. It almost feels like stealing. After years of watching hedge fund managers tell the world what hot shots they were when all they were doing was leveraging credit into ordinary investments, picking their pockets while they are down feels pretty good. You can almost correlate how much of a stock was owned by hedge funds by viewing its price percentage decline this last year.
I own Gilead as part of a long term strategy. My one suggested change for management would be that they start paying a dividend. I prefer that over stock-buy backs. Dividends allow me to choose to diversify, or to take income, without having to sell stocks and pay capital gains.
Biogen Idec reported some very impressive results today. You can get a good picture of the current state of the company at me Biogen Idec (BIIB) analyst conference summary for Q3 2008.
More data:
http://www.gilead.com/
Wednesday, August 6, 2008
Dot Hill Accelerates
Dot Hill (HILL) reported on its second quarter today, and it was quite a quarter. The long-promised turn-around has begun with a thundering 34% increase in revenue over the first quarter. See my Dot Hill analyst conference summary for September 6, 2008 to get the gist of what management said about Q2, including its answers to analyst questions.
Be warned, I own some HILL stock because I suspected this was going to happen. The company was in pretty dire straights a couple of years ago. Its stock has been dirt cheap since then, and still is. Management tried a number of initiatives while burning carefully through a pile of cash. The problem was that most of their business was supplying SAN storage products to Sun. First Sun had its well-publicized difficulties, then Sun bought a storage company and so started phasing out Dot Hill products. Adding to diffuculties, Dot Hill settled a patent dispute with rival Crossroads, giving up a substantial amount of cash in the process.
Dot Hill used its cash to support a research and development drive that took a while to pay off. Its improved storage devices first sold to a number of small equipment manufacturers and specialty shops. Then NetApp picked them up in late 2007. But the big driver of Q2 revenues was a partnership with HP, which generated about $23 million in revenues for Hill in Q2. Also a plus, Dot Hills old products are so good that Sun customers continue to buy them, to the tune of about $20 million in revenues for Dot Hill during the quarter. The Sun revenue is ramping down, but revenue from HP, NetApp and smaller vendors is ramping up much more quickly.
Dot Hill still has a ways to go to guarantee it won't become another tech has-been. It lost money on its $71 million in Q2 sales. From my point of view this is okay. The money was used to develop new products and market them. HP had special modifications made to the equipment it bought, which was expensive. Now those expenses should ramp down, although in technology there is always the next product cycle to think of. The key to profitability is decreasing production costs. Part of this happens naturally as the product cycle lengthens and the number of units sold increases. Part of it must be driven by engineering for value.
As I see it, while things can always go wrong, we are looking at a company that will soon have $300 million in annual revenues. With cost reductions there is no reason $30 million in annual net income can't be generated, maybe not in 2009, but certainly in 2010. Give that a modest PE ratio of 15, and you have a company that could have a market capitalization of $450 million within a reasonable time horizon.
What was the market capitalization at the close of trading today? Less than $114 million.
Hill has disappointed investors on a regular basis for a few years. It might disappoint again. But with $62 million in cash, guidance to $73 to $78 million in revenues for Q3, and such a low stock price, I think the upside potential far outweighs the down side.
Note again that I own some Dot Hill stock.
Keep diversified!
More data:
www.dothill.com
Be warned, I own some HILL stock because I suspected this was going to happen. The company was in pretty dire straights a couple of years ago. Its stock has been dirt cheap since then, and still is. Management tried a number of initiatives while burning carefully through a pile of cash. The problem was that most of their business was supplying SAN storage products to Sun. First Sun had its well-publicized difficulties, then Sun bought a storage company and so started phasing out Dot Hill products. Adding to diffuculties, Dot Hill settled a patent dispute with rival Crossroads, giving up a substantial amount of cash in the process.
Dot Hill used its cash to support a research and development drive that took a while to pay off. Its improved storage devices first sold to a number of small equipment manufacturers and specialty shops. Then NetApp picked them up in late 2007. But the big driver of Q2 revenues was a partnership with HP, which generated about $23 million in revenues for Hill in Q2. Also a plus, Dot Hills old products are so good that Sun customers continue to buy them, to the tune of about $20 million in revenues for Dot Hill during the quarter. The Sun revenue is ramping down, but revenue from HP, NetApp and smaller vendors is ramping up much more quickly.
Dot Hill still has a ways to go to guarantee it won't become another tech has-been. It lost money on its $71 million in Q2 sales. From my point of view this is okay. The money was used to develop new products and market them. HP had special modifications made to the equipment it bought, which was expensive. Now those expenses should ramp down, although in technology there is always the next product cycle to think of. The key to profitability is decreasing production costs. Part of this happens naturally as the product cycle lengthens and the number of units sold increases. Part of it must be driven by engineering for value.
As I see it, while things can always go wrong, we are looking at a company that will soon have $300 million in annual revenues. With cost reductions there is no reason $30 million in annual net income can't be generated, maybe not in 2009, but certainly in 2010. Give that a modest PE ratio of 15, and you have a company that could have a market capitalization of $450 million within a reasonable time horizon.
What was the market capitalization at the close of trading today? Less than $114 million.
Hill has disappointed investors on a regular basis for a few years. It might disappoint again. But with $62 million in cash, guidance to $73 to $78 million in revenues for Q3, and such a low stock price, I think the upside potential far outweighs the down side.
Note again that I own some Dot Hill stock.
Keep diversified!
More data:
www.dothill.com
Tuesday, August 5, 2008
Rackable Systems Disappoints, Promises
Rackable Systems (RACK) reported Q2 revenues that were up 12% over Q1 ($76 million v. $68 million). There are high expectations for Rackable, so the impressive sequential increase was not enough to compensate for the poor bottom line. Even on a non-GAAP basis there was a net loss of $3.5 million, or $0.12 per share. The GAAP loss was amplified by an impairment charge of $16 million to $28 million or negative $0.95 per share. [See my Rackable (RACK) analyst conference summary for August 4, 2008 for a full report]
The impairment charge was because they are "looking at strategic options" for their RapidScale storage technology, which they acquired only a few years ago, and which was supposed to help them grow into a much larger company. Obviously they expect to sell the division for less than they acquired it for, hence the write-down.
The sequential increase in revenue was marred by a single sale where management decided to make a substantial price cut to get the business. They would not name a client or a dollar amount, but they believe this one-time transaction will lead to future profitable sales.
There are, however, reasons for optimism. Management did not lower the guidance for 2008. They expect revenues of at least $353 million, which implies that Q3 and Q4 revenues will be over $100 million each, which would be quite a jump.
They have some reasons for this optimism. In a bull market the bulls would be swarming all over these "forward looking statements." The backround is their claim, upheld by independent researchers, that their technology is far more energy efficient than that of their competitors (Sun, HP, IBM, etc.). In addition to their standard data center and Internet server farm technologies, they have a product called the ICE Cube, which is a portable server farm in a standard storage container. They have been talking about this for well over a year now, and they finally completed their first sale after Q2 ended. At least as important, IBM has decided to partner with them on the ICE Cube by supplying its own blade servers (BladeCenter); presumably IBM will do the marketing on this joint product. Raytheon is also partnered with Rackable to sell ICE Cube technology to the government; it is particularly attractive for military applications.
For their standard servers (the Eco-Logical line), they had their first sale in the energy (petroleum) vertical market. About 65% of revenues were generated with sales to their current major clients, Amazon, Yahoo, and Microsoft.
And even the RapidScale debacle has its upside. They expect to announce a new, global storage partnership soon. So they don't need RapidScale as badly as some giant computer corporation needs their server farm technology.
They even made their first sale in Japan. Rackable has had weak international sales, but is working on that problem with partners.
I own Rackable stock; I am certainly not selling it at this point. Rackable has disappointed investors over the past two years, and profitability has been elusive. If you don't own the stock you might want to wait until Q3 results are in, to see if management can make good on its promises.
As always, keep diversified.
More data:
www.rackable.com
Openicon Rackable Page
The impairment charge was because they are "looking at strategic options" for their RapidScale storage technology, which they acquired only a few years ago, and which was supposed to help them grow into a much larger company. Obviously they expect to sell the division for less than they acquired it for, hence the write-down.
The sequential increase in revenue was marred by a single sale where management decided to make a substantial price cut to get the business. They would not name a client or a dollar amount, but they believe this one-time transaction will lead to future profitable sales.
There are, however, reasons for optimism. Management did not lower the guidance for 2008. They expect revenues of at least $353 million, which implies that Q3 and Q4 revenues will be over $100 million each, which would be quite a jump.
They have some reasons for this optimism. In a bull market the bulls would be swarming all over these "forward looking statements." The backround is their claim, upheld by independent researchers, that their technology is far more energy efficient than that of their competitors (Sun, HP, IBM, etc.). In addition to their standard data center and Internet server farm technologies, they have a product called the ICE Cube, which is a portable server farm in a standard storage container. They have been talking about this for well over a year now, and they finally completed their first sale after Q2 ended. At least as important, IBM has decided to partner with them on the ICE Cube by supplying its own blade servers (BladeCenter); presumably IBM will do the marketing on this joint product. Raytheon is also partnered with Rackable to sell ICE Cube technology to the government; it is particularly attractive for military applications.
For their standard servers (the Eco-Logical line), they had their first sale in the energy (petroleum) vertical market. About 65% of revenues were generated with sales to their current major clients, Amazon, Yahoo, and Microsoft.
And even the RapidScale debacle has its upside. They expect to announce a new, global storage partnership soon. So they don't need RapidScale as badly as some giant computer corporation needs their server farm technology.
They even made their first sale in Japan. Rackable has had weak international sales, but is working on that problem with partners.
I own Rackable stock; I am certainly not selling it at this point. Rackable has disappointed investors over the past two years, and profitability has been elusive. If you don't own the stock you might want to wait until Q3 results are in, to see if management can make good on its promises.
As always, keep diversified.
More data:
www.rackable.com
Openicon Rackable Page
Tuesday, July 15, 2008
Genentech Pipeline and Analyst Conference Summary
I listened the the Genentech (symbol: DNA) Q2 2008 analyst conference yesterday in order to write my summary of the event. In fact I listened to most of it twice. I don't own Genentech stock. I currently own ANSV, DNDN, BIIB, GILD, and CELG among the biotechnology companies. I prefer simpler stories, in particular where one or two relatively new drugs are apt to make a company's fortune. But after listening to the presentation and looking at the slideshow, I am thinking about putting the July cash designated to be converted into undervalued stocks into DNA. Short term I don't expect much from it, but in the coming decade I suspect we are all going to wish we had a position in Genentech.
Why? Because of the enourmous breadth of Genentech's pipeline. Just mentioning all of the trials taking place right now requires a document pages long. There are trials to extend the labels of blockbuster drugs like Avastin. There are trials for hitting cancers earlier or later than is currently recommended, and for hitting different varieties. There are trials of a variety of new drugs for cancer and other indications. There are whole new bits of science that are in preclinical trials (they are not yet being tested on human beings).
Of course, even a successful company like Genentech will have failures. The failure rate for drug candidates is very high, though by the time a drug makes it to Phase III its chances are getting reasonable enough for investors to bet on. Genentech announced both failures and successes already this year. When you try so many drugs for so many different diseases, that is what you will get.
Remarkably, Genentech is solidly profitable despite the heavy investment in drug development. GAAP earnings were $0.73 per share in the quarter just reported. At this moment it is up, trading for $79 per share. That gives it a current (not trailing) PE of 27, which sounds high in this current market where growing companies sometimes have current PEs in the 10 to 15 range. But compared to the past, this is not a high PE for DNA. Just the growth trend lines in its current drug line up could justify today's price.
Look at the summary of trials and pipeline developments on pages 13 through 41 of the slideshow. There are risks, certainly, but on the whole I believe some remarkable profits are going to be generated in this next decade from the winners in the pipeline.
Why? Because of the enourmous breadth of Genentech's pipeline. Just mentioning all of the trials taking place right now requires a document pages long. There are trials to extend the labels of blockbuster drugs like Avastin. There are trials for hitting cancers earlier or later than is currently recommended, and for hitting different varieties. There are trials of a variety of new drugs for cancer and other indications. There are whole new bits of science that are in preclinical trials (they are not yet being tested on human beings).
Of course, even a successful company like Genentech will have failures. The failure rate for drug candidates is very high, though by the time a drug makes it to Phase III its chances are getting reasonable enough for investors to bet on. Genentech announced both failures and successes already this year. When you try so many drugs for so many different diseases, that is what you will get.
Remarkably, Genentech is solidly profitable despite the heavy investment in drug development. GAAP earnings were $0.73 per share in the quarter just reported. At this moment it is up, trading for $79 per share. That gives it a current (not trailing) PE of 27, which sounds high in this current market where growing companies sometimes have current PEs in the 10 to 15 range. But compared to the past, this is not a high PE for DNA. Just the growth trend lines in its current drug line up could justify today's price.
Look at the summary of trials and pipeline developments on pages 13 through 41 of the slideshow. There are risks, certainly, but on the whole I believe some remarkable profits are going to be generated in this next decade from the winners in the pipeline.
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