The Cross-Border Biotech Blog

Biotechnology, Health and Business in Canada, the United States and Worldwide

Some Questions When Considering Investing in Canadian Healthcare Stocks: Part 22 of Valuation and Other Biotech Mysteries

[Ed. This is the twenty-second part in Wayne's series. You can access the whole thing by clicking here. Please leave comments or questions on the blog and Wayne will address them in future posts in this series.]

Note: as with all commentary on this blog, these comments do not consider the investment objectives, financial situation or particular needs of any particular person, and investors should obtain professional advice based on their own individual circumstances before making any investment decision.
If you and your financial advisor(s) are discussing investing in Canadian healthcare stocks, here are some points for you to consider.
  • A good place to start is your investment objectives and risk tolerance. The objective at the lowest end of the risk spectrum is risk-free yield, and the objective at the other end is extraordinary capital gains from high-risk investments.
  • The classic strategy for risk management is portfolio diversification. This strategy will not help with systematic or broad market risks, which can be impacted by factors such as interest rates and geopolitical conflicts. Diversifiable risk relates to specific products, asset classes, companies and industries. There are many academic and market-based studies examining how many stocks provide optimal diversification. I remember 17 as the number given during a microeconomics course about 30 years ago and I saw 20 to 40 stocks mentioned as a practical number which considered time and cost for due diligence to choose those stocks.
  • One classic investment strategy is ‘buy value and hold’. This strategy is applicable to companies in any industry whose value can be readily assessed based on a history of revenues, earnings, growth and dividends.
  • A small number of Canadian healthcare companies would meet the investment objective of acceptable yield with moderate risk and the opportunity for some capital gains. There are companies in many industries and countries which could be described in a similar manner, although they would have different sector-specific risks and sector-specific opportunities for growth.
If you are considering a portfolio with the objective of acceptable yield with moderate risk and the opportunity for some capital gains, ask the following questions at a minimum.
  • Is the portfolio Canadian, another geographic focus or global?
  • Is the portfolio market-wide, industry-specific, excludes certain industries or includes a small number of industries?
  • Is there a market cap range or minimum for the portfolio?
  • Is this a ‘buy and hold’ or a ‘trading’ portfolio?

If yield is not an objective for a specific pool of capital, then capital gains are the sole objective. If biotech stocks (including novel therapeutics, devices and diagnostics) are a potential component of that investment portfolio, ask the following questions.

  • What size capital gains are being targeted – twice broad market gains on an annual basis, or doubles or ten-baggers on individual stocks?
  • Is the portfolio Canadian, another geographic focus or global?
  • Is the portfolio market-wide, industry-specific, excludes certain industries or includes a small number of industries?
  • Is a specified portion of the portfolio for biotech companies? If yes, ask the following questions.
  • Is there a minimum market cap? If the minimum market cap is $1 billion, only Valeant Pharmaceuticals and Paladin Labs have a TSX listing and meet that minimum market cap. However, I would consider these two companies to be mature pharmaceutical companies, valued on the basis of revenue and earnings, rather than biotech companies with valuation based on products still in development. If the minimum market cap is $100 million, there would be about 20 Canadian companies from which to choose.
  • Is there a geographic limitation? There are about 50 biotech companies worldwide with market caps over $1 billion, and probably about 500 companies if the market cap minimum is $100 million.
  • Is there a disease focus or limitation?
The questions to this point could be useful in structuring or assessing an investment portfolio of companies valued on the basis of revenues and earnings for which ‘buy value and hold’ might be a reasonable investment strategy. However, this is not what most readers of this blog probably want to read here – they want to know how to pick the winners from amongst the 1,000+ worldwide micro and small cap biotech companies. On that question, let me make three points:
  • No investor, or pharma company, can consistently pick the winners;
  • Some investors can pick more winners than other investors; and
  • Some investors can avoid more losing investments than other investors.
In the following two posts, I am going to look at the following points.
  • Canadian small cap investors probably have done most of their investing in resource companies – the strategies used there are applicable to biotech.
  • In contrast to the buy and hold investment strategy, I think that event-based trading is a more practical approach to biotech investing.
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