A business need not be profitable all the time

This must be one of the most wiered statements you must have ever read about fundamentals of business.After all every text book says the same stereotypical things like the business should have great margins, should have great return on invested capital, should have low fixed costs...bla bla bla....But there is one industry that is totally different and none of these rules apply to them. Yeah I mean it and I have some solid data to prove it.

The Industry is BIOTECH industry.Its one of the few industries which are heavily dependent on R&D and the success of the company in growing its research is the main factor that counts. Let us consider the following example.

ILLUMINA (ILMN)- Following is its 5 year stock performance.

As we can see that the stock has just been on tear for last 5 years. The company was founded in 1998. The best way to get the snapshot of the company's progress since its inception is looking at its stockholder's equity.

Additional paid in capital            : $1,566 mn
Accumulated deficit                 : ($309 mn)
Treasury stock at cost               : ($322 mn)
TOTAL BOOK VALUE          : $939 mn

Following has been the company's revenues and earnings last 8 years

YEAR               REVENUES               INCOME
2008                   $573 mn                       $50 mn
2007                   $366 mn                     ($278 mn)
2006                   $184 mn                     $39 mn
2005                   $73 mn                       ($20 mn)
2004                   $50 mn                       ($6 mn)
2003                   $28 mn                       ($27 mn)
2002                   $10 mn                       ($40 mn)
2001                   $2 mn                         ($24mn)

Its interesting to see that the company has nade losses in 7 out of last 8 years. But the stock is a 10 bagger. But this does not mean that the intrinsic value of the company has not increased. Because such sustained long term growth in stock does not come from mere speculation.

Usually in other businesses the growth in intrinsic value is reflected in the growth in earnings but not in case of most of Biotech companies. So what are the factors we need to measure while analyzing a biotech business???

Does macroeconomics hit all businesses?

MACROECONOMICS is the study of economy in general. They say that if the economy is down then it affects all the businesses, well sometimes it might not be true. Following is an example that demonstrates that fact.

SPECIALTY ITALIAN RESTAURANT : Let us say that there are 10 specialty italian restaurants in the town. Each caters to around 1,000 customers per week. Assuming each person spends around $20.00 So that means the total market for Italian food is $20,000 / week. Revenues / restaurant is $2,000 / week.

If the economy of the town goes down and unemployent increases then let us say that the number of people visiting Italian restaurants is half now and each spends just $10.00. So that means the total market for italian food now is $5,000 / week,

But if 8 of those 10 restaurants go out of business then that means this $5,000 is shared by the remaining two restaurants .Making Revenues / restaurant is $2,500 / week.So we saw that in the down economy the top businesses infact could increase their revenues, this could happen if the competition decreases in faster rate than the total market. The challenge is to identify such top businesses.

Getting a nice parking spot

One of the most common complaint I have is "Not getting a nice parking spot at work". Especially in those winter days when there is snow all over and I have to drag myself in the blistering cold wind for about 20 minutes to get to my car. One of the most simple solution to this problem is to get to work early and take a nice parking spot that's closest to the main entrance. Well That's only possible if I wake up early. But I am not a morning person????


Last Monday when I showed up to work around 9:30, I still managed to get the best parking spot.IT WAS JUST 20 FEET FROM THE MAIN ENTRANCE. Its because I was just dammn lucky.When I was entering the parking lot I saw a guy pull out and I just sneaked in to his parking spot.It might be that the guy had a doctor's appointment or something. Well who cares, I got a great parking spot. Infact I came out of the car and stood there for a minute , getting the feeling of being triumphant. And obviously could not stop myself from boasting my great achivement.

Well what's this pathetic parking lot story to do with investment strategy????if we carefully analyze, all the great things in one's life comes only after a lot of hardwork and perciverence. Starting with our college degree to getting our first job or buying or first home. We had to toil a lot to get all these accomplished. Hey , even writing this article is taking me around half an hour.

So if one asks what the best strategy for getting a nice parking spot? the answer is to come in early to work, period. Even though it involves sacrificing my sleep but the reason its the best strategy is because the results are very much predictable.

GOAL OF AN INVESTMENT STRATEGY : To build a process of selecting Investment products where the results are pretty much predictable. Going back to my success of getting a nice parking spot, it was just that I was lucky. There is no way I can show-up every day at 9:30 and hope to get a nice parking spot.

THE MOST COMMON MISTAKE PEOPLE DO WHILE BUILDING THERE INVESTMENT STRATEGY : Its to look at what kind of return they can get in short term. But they ignore to analyze if its predictable or not. They are just counting on being lucky. Internet is full of such sites that profoundly offer to get me "A nice parking spot even if I showup at 9:30".Its because we as humans have the tendency for instant gratification and to achieve that we are ready to ignore even the basic rules of life. i.e. GOOD THINGS COME TO PEOPLE WHO HAVE PATIENCE 

Thinking like a Mortgage Lender

Once in a while I ponder upon a chapter in the book The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition).Last week I went thru the chapter "Defensive investor and common stocks".Note on the concept of risk portrays a very interesting aspect of Investment psychology.It shows how we think differently about risk when it comes to stocks and bonds and always think about the latter as more safe and former as risky.But if we carefully analyze then a bond can be risky and a stock can be safe.Following is a little example that explains this fact.

"THINKING LIKE A MORTGAGE LENDER"I guess this might be one of the most startling articles you have read , given the present scenario of the sins of mortage business and its after effects felt throughout the world.No matter how much we curse these so called "Mortgage experts", we cant ignore the fact that the spectacular growth of USA economy since world war-II has been because of the rapid growth in housing and auto industry.

A house and a car are two biggest assets held by any average person.The lenders for these are always focussed on there interest and principal payments.Till they are getting that every month they are happy.Let us take the following case study.

John , who was 30 years of age in 1984 bought a house in California.He takes a loan of $100,000 for buying it.The bank charges 6% interest and expects the payment of the whole principal in 15 years.By 1999 John Fullfills all his obligations and at the end both John and his bank are happy.

But if we analyze the time period from 1984 to 1999.The things were not always great.In 1990 the housing market crashed.John's house lost 30% in value.And he also was unemployed temporarily for 6 months.Being a financially conservative person, he had ample resources to weather the storm.

What if the bank would have leant money to Tom who was a party animal always living off paycheck to paycheck.The moment tom would have lost his job, the bank would have required to foreclose his property and in the process would have been forced to take a hit.

So the lesson learned from this deal is that if we as an investor think like a mortgage lender, lets re-phrase it as "A CONSERVATIVE MORTGAGE LENDER", then in long run we will come out good.But only if we avoid :

1. Being forced to sell at a time when its not good for selling.
2. Lending money to aggressive guys who donot maintain a cushion for the tough times.