People revere Warren Buffett as the greatest investor on the planet but even he has big blind spots. For me, one of the biggest is cheerfully buying banks, trains and pipelines while refusing to look at biotech stocks.
It’s not like he doesn’t have the money. Berkshire Hathaway Inc. (NYSE:BRK.A) is now sitting on $128 billion in cash and Buffett spends a lot of time complaining that there are no elephant-size acquisitions worth buying.
And the magic of biotech is that even the biggest names in the industry are still a long, long way from becoming the $1 trillion behemoths Buffett loves. He could buy the four largest profitable biotech stocks without running out of cash.
Raise Your Horizons
That single move would raise his profit 30 percent overnight. Suddenly Berkshire Hathaway has a growth engine that runs faster than the ambient economy.
Remember, that’s theoretically a key piece of the investment process Buffett inherited from Benjamin Graham. You want to overweight dynamic businesses while steering clear of stagnation.
Chewing gum, batteries, underwear and car insurance generate plenty of cash, but we can all agree that those industries are mature. At best, they’re growing 3 percent a year, inching ahead of inflation.
Biotech, on the other hand, has almost unlimited potential to transform human life. These companies are fighting to eradicate cancer and other diseases. A few are even trying to reverse the aging process.
While they’re a long way from those big goals today, even incremental progress can liberate shocking amounts of cash. And from today’s relatively narrow base, those future scenarios are the stuff most investors dream about.
Take a look at the most “mature” of today’s biotech stocks, Vertex Pharmaceuticals Inc. (NASDAQ:VRTX). It’s a big company here at $50 billion in market cap, but as far as modern Wall Street is concerned, a stock like this is only a sideshow compared to the smallest of the Silicon Valley giants.
VRTX is also more profitable than Netflix Inc. (NASDAQ:NFLX) today and is growing faster as its therapies for conditions like cystic sclerosis and muscular dystrophy move through the clinical pipeline. By 2023, I expect cash flow to triple.
Compare that to what chewing gum and batteries are doing for Berkshire Hathaway. Buffett would say he’d rather invest in a steady business with no surprises, but that’s not really a good argument to make here.
Reliability is wonderful if you’re looking to protect existing wealth. In that world, you really want something like a bond that won’t make you worry about its ability to keep the cash flowing.
Stocks are about trusting that the future will be better than the past and that the stocks you pick will provide the sizzle in that story. We’re all about the possibilities. Sometimes we’re disappointed but all in all the outcomes are thrilling.
The key is to spread your exposure so you capture enough of the thrills to offset the disappointments. For every zero in your long-term portfolio, you want to have at least one double-the-money win.
In the world of venture capital, you’ll probably do much better than that. Innovation is an economic force. Shut it out of your world and you lock out the rewards as well as the risks.
I think that’s the world Warren Buffett lives in. He ignored Silicon Valley for decades because he didn’t understand the products in the same way that he can know how good chewing gum tastes. Now he ignores the entire biotech industry.
It’s his choice. He’s built an amazing bond-like business over the decades, throwing off reliable cash. Unfortunately, if he can’t find any good investments now, it’s his own fault.
Berkshire Hathaway gave investors an 8 percent return so far this year. The biotech stocks are collectively up 13 percent. Buffett’s cash earned 2 percent at best.
The math itself is begging the Sage of Omaha to get more aggressive. He doesn’t have to know the inner workings of the cell or how DNA works. All he needs is a budget to hire experts to translate the miracle of sick kids living happier, more productive lives into investment terms he can understand.
He might come back and say the group as a whole isn’t mature or that the stocks are overpriced. I get that. But he’s happy to buy Berkshire Hathaway shares at 35X earnings now, right?
VRTX is a little more expensive than that at 40X earnings. But the next-biggest biotech name on my screen, Regeneron Pharmaceuticals Inc. (NASDAQ:REGN) trades at barely a 13X multiple.
It’s profitable. The business is stable and looks like it will grow at least twice as fast as Berkshire Hathaway well into the next decade. And there’s always the chance of a laboratory breakthrough transforming the company.
Buffett could let his cash sit in the bank or he could buy this company. He’s happy to own $1 billion in Amazon.com Inc (NASDAQ:AMZN) at a nosebleed 86X earnings valuation.
If he isn’t willing to bet on the medical discoveries of tomorrow, I don’t think he’s really serious about wanting to put his money to work. Let future generations of fund managers deal with it. We’re making our money in the here and now.
As you know, my GameChangers trading service is never far from the biotech world. And I have a few ideas brewing that will make real innovation seekers extremely happy. Watch this space.
CANNABIS CORNER: REEFER REIT ROCKS THE MARKET
It’s easy to criticize the bad match between most cannabis stocks and the street-level economic potential. Deregulation is creating a multi-billion-dollar industry. The stocks need a lot of work.
But dig beyond the Big Cannabis cultivators flooding the world with raw plant product and there are plenty of hot spots for investors. Innovative Industrial Properties Inc. (NYSE:IIPR) is one of the brightest.
The business model here is a little different. IIPR doesn’t grow anything. Instead, the company owns 2.8 million square feet of greenhouse space that it leases to medical marijuana cultivators.
All the slots are full and generating rent, which IIPR then passes back to shareholders. That’s right, IIPR is a Real Estate Investment Trust or REIT. This is a cannabis dividend play.
The yield isn’t huge right now at 3.8 percent, but that’s where IIPR gets interesting. Demand for greenhouse space is exploding, giving management a lot of leeway to raise rent and ultimately enrich the dividend year by year.
Two years ago, IIPR paid $0.15 per share quarterly. Here we are now at $0.78, a full 420 percent beyond that minimal starting income stream.
And the sky is the limit. We just got quarterly numbers that blew Wall Street’s most aggressive targets away: revenue practically tripled over the past year. Even management called the growth rate “tremendous.”
Part of that cash lays the groundwork for additional expansion. Since July, the property portfolio has doubled in size, so I expect at least 150 percent dividend expansion over the next few years as those greenhouses fill up with tenants.
Commodity math is our friend here. Growth space is an absolute necessity for any licensed cultivator. While anyone can build a greenhouse, funding restrictions make it tricky for start-up growers to write their own checks.
For many, renting is the only option and IIPR is the only game in town. Admittedly, management has financed its expansion by selling stock, but even after diluting existing shareholders there’s still plenty of cash to go around.
Investors who sold that story over the summer now need to come running back. After all, the float is still extremely narrow.
With under 10 million IIPR shares on the market six months ago, we now live in a world where every $1 of profit needs to stretch 14 percent farther to keep all the year-over-year comparisons the same. That’s no problem when cash flow coming in triples.
Admittedly, I’m biased. Since I added IIPR to my Turbo Trader Marijuana Millionaire Portfolio, it’s beaten the big cultivators by 13 percentage points.
We’re booking dividends quarter to quarter. And with the stock up 13 percent this week, I’m looking for a big long-term payout here soon.
Which business will transform the aging world and bring investors life-changing profits? Hilary Kramer knows. She reveals the name of this company – “The Final Human Frontier: An Aging World” – and much more in her blockbuster new book, GameChanger Investing: How to Profit from Tomorrow’s Billion-Dollar Trends.
To get a FREE e-copy of the chapter naming “The Final Human Frontier: An Aging World,” simply tell us where to send it in the box below.