Wednesday, May 11, 2016

Taking My Medicine With IBB

For a long time I sat on the sidelines thinking about this purchase. All through 2012-2015 I watched as this ETF smashed to new highs seemingly every day.  At one point from 2012 it was up an astonishing 230% compared to the S&P 500's 62%. I finally decided to pull the trigger yesterday and add the iShares Nasdaq Biotechnology ETF(IBB).

There is a reason why I went with the ETF instead of an individual name such as Amgen or Biogen. Which if I was forced to choose an individual name I'd go with one of those. I like the ETF since its two largest holdings are Amgen and Biogen. There are also 187 other companies currently in the fund which offers diversification to help mitigate risk.  Risk is higher in this industry.  I'm not a scientist and I hate doctors. So my expertise in this area is very low, and the commercial viability of new treatments is a risky undertaking to begin with. That being said it's of my opinion that evaluating the financial performance of a company and it's fundamentals in this industry only go so far. Millions of dollars could be spent researching a drug only to have the FDA deny it.  Then there are lawsuits, and the overhang of political whiplash.Warren Buffet is known for buying what he understands. Well I don't understand a lot of this stuff, but I do understand there's a lot of money to be made. So I need to protect myself the best I can in this situation while still affording myself to invest in a good opportunity.

Biotechnology stocks offer a certain type of moneymaking opportunity.  It''s not the most capital light business as R&D costs can be substantial and ongoing.  Yet the best run outfits can realize profit margins north of 30% after everyone is paid.  That's way better than the tobacco industry which is one of my favorites. Better yet the drugs produced are granted monopolies albeit for a limited time.  So a successful drug can make up for 10 bad ones.  Sometimes a single drug can generate billions of dollars in revenue each year. I'm taking this industry over the traditional pharmaceutical industry for a few reasons. Biotech companies are producing drugs that are much different from traditional pharmaceuticals. That gives them a scientific and competitive edge. Additionally these companies are on average better at researching and developing new breakthroughs. The traditional Pharma industry is on whole weaker in this department so I don't want any of that. Just note the fund is only 77% biotech, and includes a 14% weighting towards Pharmaceuticals, 7% towards Life Sciences Tools & services, and fraction of traditional Health Supply companies.

Of course the downside is periodic political pressure regarding  price gouging of patients, insurers, and the government itself.  The regulatory framework is undoubtedly a risk. But the industry has backing behind closed doors due to the many high paying jobs they create. As long as the majority of those jobs stay on our shores I'll think the industry will be able to hold its own against an angry politician. That doesn't mean I'm setting and forgetting this one like normal.  If it looks like the operating landscape will change I'm going to be quick to cut this out of the portfolio.  As I said before I'm not the best at understanding everything in this industry. But I understand when people are sick they increasingly look towards the type of drugs these companies produce to extend or save their lives.

The ETF according to the iShares website currently trades at a P/E of 21.  Not terribly cheap, but much cheaper than it was in 2015.  The shares have seen a fall from $400 to a recent low of $237. Shares are at or near oversold levels on the monthly, weekly, and daily charts so I feel somewhat re-assured by the technicals the downside is limited here. I don't expect this to be a rocket ship back to $400 either. Although over a few years I expect this sector to continue outperforming the market.

Feel free to share your thoughts on this pick!

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