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The Pharma "Big Idea"


Contrarianism is cute, but it don't buy nuthin'


Surveys of market pundits (buy side and sell side) have repeatedly placed pharmaceutical companies at the top of the list for companies that are most undervalued. Over the last few months, a chorus has arisen for people to buy these "undervalued" large pharmaceutical companies. This chorus was (self?) validated by the end-of-year run in Pfizer (PFE).

This time last year, I would have jumped up and down (and did) saying that pharma should be avoided. Wall Street did not fully appreciate the impact of generics, had not fully accounted for their bereft pipelines, remained oblivious to more aggressive cost controls by insurers, and was generally ignoring the sorry state of affairs at most of these companies.

Since then:

• Lipitor sales growth stalled due to many insurers requiring docs use generics first

• Lipitor's sales stall woke people up to the risk of generics on the entire class, not just to the company whose drug is going off patent

• Pfizer pulled their guidance, citing lack of visibility due to generics and pipeline issues

Merck's (MRK) (via Vioxx) continues to be the poster child for the fact there is overnight risk in multi-billion-dollar companies just like there is in biotechs

So would I counsel against diving into pharma stocks here? Well, we don't do advice here in Minyanville, but I do have some thoughts on the matter:

• This crowded trade is likely to get more crowded. Sling arrows at me about how trends are not my friend or deride me in terms of the Greater Fool Theory*, but last time I checked it was a good thing to own a stock many people are about to buy.

• Involvement in "the popular trade" demands you not get greedy and requires you to be ruthless about cutting losses. You don't want to be the Greatest Fool.

• The fundamental question for any investment in pharma is when (if) the psychology changes concerning the torrent of biotech licensing and acquisitions to come in 2006.You need to work the phones to your buddies to understand how fellow shareholders will react to this torrent. If you can determine exactly when the psychology of pharma investors will morph from "repairing the pipeline" (bullish) to "endangering the balance sheet and/or the dividend" (bearish), you'll have a fundamentals-based exit point.

I still would rather be invested in the acquisition targets, but I understand my alternate universe of dev-stage biotechs is not for everyone. It makes sense to me, particularly given the run in Pfizer at the end of last year, why pharma is so popular these days. These companies are still broken, in my opinion, but that does not mean you cannot make money off them. Just take care and make sure a trade doesn't turn into an investment.

* The Greater Fool Theory became popularized in the 98-00 phase of the last bull market. Commonly used as a derisive term, it describes the ability to make money by buying an "overvalued" stock and selling it to someone else at an even more overvalued price. The implication is you were a fool for buying the overvalued stock, but the person you sold it to for a profit was the "greater fool." Last I checked, that profit spends the same as the money made from buying an "undervalued" stock and selling when it reaches "fair value."

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No positions in stocks mentioned.

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