(Fourth in a Series of Pharmacy Articles)
Companies that manufacture drugs come in all sizes. An investor in the Bio-Pharma stock world needs to know what these sizes are and what they mean. In general, as in all segments of the market there are very large companies, very small companies and all sizes in between. There are advantages and disadvantages in investing in different size companies in the Bio-Pharma market place.
The biggest companies are generally known as large-caps. Such familiar named companies as Merck, Pfizer, Bayer, Roche, Lilly, Johnson and Johnson, Abbott, Glaxo-Smith, Novartis and Bristol Meyers Squibb are a few of these. These companies are huge and produce an excellent array of drugs and medical devices. In general, these companies are safe long term investments which almost always rise in value over time. These companies have the wealth and the facilities and infrastructure to constantly develop new drugs. They have the expertise to get this done along with the hoards of cash required but they too can run into dead ends. But the dead end projects will not cause the company to close or to really lose any significant value.
As an investor in these companies one is thus pretty safe from devastating loss. But, the flip side of this coin is that an investor in these companies is unlikely to ever make a big sudden profit or hit if you will on the upside. This is because even when and where these companies do develop a new blockbuster drug the share price of such a large company isn’t going to change that much on that up side. In short, it is a safe investment with limited up or down side movement. Look at it this way, if a company with billions of dollars of worth and a share price of $250.00 develops a blockbuster drug that results in a $125.00 increase in price per share then investors make a 50% profit. I ask you to hold this number in your head for a moment as we will come back to it.
A Mid-Cap company is smaller than a Large-Cap and then we have SmallCap companies which are smaller yet. These three levels of companies are usually well established, well run companies that are listed on the stock exchanges. They are thus legitimate companies. Smaller than this are the microcap companies (also listed) and then beneath this are the “penny” stocks (not listed). In general “penny” stocks are called “penny” stocks because that’s what they’re worth. These are very new, very small companies that have not established themselves in the business world yet. In general these are public companies that are not listed on the exchanges given that they trade less than around $2.00/share and are not safe. They have a high propensity of failing and making your stock purchase worthless.
In a previous article I mentioned how rare it was indeed for a little company to develop a blockbuster drug because of the time and expense and the rigors of passing FDA approval to develop and sell such a drug. Unlike the Large-Caps (with lots of cash and many products) these companies are almost always a one product show with limited funding. If they fail, which the vast majority do, they are wiped out which means that you are wiped out. Whatever amount of stock you bought, even at a cheap price, will be wiped out. Remember, you don’t have to buy a high priced stock or a Large-Cap stock to spend a lot of money. Berkshire-Hathaway A stock costs $300,000.00 /share and it is a good safe stock from a great company owned by a great and wise American hero by the name of Warren Buffett. If you can handle this cover charge you have a good safe stock. But, that doesn’t mean that you can’t spend $300,000.00 on a penny stock because one can easily buy 300,000 shares of a $1.00 stock. The person who does this is betting big to try and make a big fast killing but usually the stock fails and the killing that is made becomes a suicide.
So, between the very dangerous “Penny” stocks and the main stream Small-Cap stocks are the Micro-Cap stocks. These stocks are usually trading between $2-$10 and are thus larger than “Penny” stocks but smaller than SmallCaps. Therefore they are riskier that Small-Caps and safer than “Penny” stocks. But the allure to Micro-Caps is that this is the sweet spot in the Bio-Pharma market where, if you’re careful, fortunes can be made. The basic reasoning here is that these companies have graduated out of the “Penny” stock world meaning they must be doing something right. They have not yet really been noticed even though they are listed and they have yet to move up to main stream Small-Cap status. THEREFORE, those Micro-Caps who are working on a potential blockbuster drug product can be purchased at relatively cheap prices. This, for the patient investor, can pay off in a bonanza in select cases.
Let’s now go back and consider the $250.00 purchase price of a Large-Cap company whose stock goes up $125.00/share on development of a new blockbuster drug. This is a 50% rise in share value. The investor now made $125.00 and has a total new position worth $375.00. If a Micro-cap company trading at $3.00/share goes up $125.00/share this is a approximately a 4,000 percent rise in share value. So, if an investor spent the same amount of money to buy shares in the first place as did the investor in the Large-Cap did ($250.00) then he would have had about 80 shares of that stock (since the Micro-Cap was 80X cheaper; $3.00/share as opposed to $250.00/share). The Micro investor thus made a profit of 80 X $125.00 or $10,000.00 compared to the Large-Cap investor profit of $125.00. The Large-Cap investor had a much safer position in that the odds were much more likely that his bet would not lose and that the Micro-Cap investor would lose for if the Micro-Cap failed the $250.00 would have been gone. Obviously, investors in such calculated plays invest much more than 80 shares and this is where the profits can get huge as 800 shares would have paid off $100,000.00 and 8,000 shares $1,000,000.00.
The trick is to know how to look for Bio stocks and to do this an investor needs to know what the drug does medically, where it may fit in with medical care and what the down sides are. But also the investor needs to know about the business side of the company because bad practices there or under funding can destroy the company with a good drug just as a bad drug can destroy a well run, well funded company.
But at the end of the day, it is in the Micro-Cap sector where one has a chance to hit it big. That doesn’t mean it’s easy because it isn’t. The idea, I think, for those who want to play a little and have a shot a big riches is to have the discipline to take not more than 10% of your assets and maybe place your bet on a diamond in the rough company or two. My goal, in part, is to help investors understand the medical aspect(s) of the company which is about 50% of what you need to know to make a decent, well calculated decision. This information, along with well researched information on the business side of the company gives you a better whole view of the investment.