Must watch video about Benjamin Graham and his legacy.
Brexit is coming. Yesterday, Theresa May took place in Downing Street. One of the first movement she took was to point out Boris Johson as foreign secretary. Mr. Johson has been a very active Brexit leader.
In relation to the Brexit situation, the mother of all questions is: How Europe will be affected by the Brexit? This is good picture that I found, the heat map summarized European sovereigns’ external vulnerability:
For the macro perspective this chart is awesome. Among the biggest countries in Europe, Germany and France, are those that do not have an elevated vulnerability with the UK. On the other hand, Spain, Italy and Ireland have a few or more red boxes. With this heat map in mind, you will imagine how tough the negotiations will be between the UK and the UE.
To the other side, a micro outlook, is great. The Brexit Value Effect.
Boris Johnson – The Irresistible Rise.
Must watch interview of Jorge Paulo Lemann, one of the owners of 3G Capital.
Jorge Paulo Lemann is Brazil’s richest man thanks to his stake in Anheuser-Busch InBev, the world’s largest brewer, which he owns through private equity firm 3G Capital together with fellow billionaires and longtime partners Carlos Sicupira and Marcel Herrmann Telles. The trio also has stakes in Restaurant Brands International, which owns Burger King and Tim Hortons and is listed both the New York and Toronto stock exchanges. In 2013 Lemann’s private equity firm bought H.J. Heinz & Company for $23 billion together with Warren Buffett’s Berkshire Hathaway. It was 3G Capital’s second acquisition of an American name brand. In 2010, 3G Capital bought Burger King in a leveraged buyout. Lemann is a former Brazilian tennis champion who played at Wimbledon. He has lived in Switzerland since 1999, after an attempted kidnapping of his children.
I have been reading for a few weeks the book called “The five rules for successful stock investing”. For those who do not know it, the author is Pat Dorsey. Former Director of Stock Analysis at Morningstar. Right now Pat is working in his own company called Dorsey Asset Management.
From my point of view, the book is simply for begginers, clear and well-written. The classic book that you can re-read every year. I found the last 13 chapters as a reference guide or 101 XXX industry. Here are my notes from the chapter called “Health Care”. Highlight:
- Health care is one of the few areas of the economy that’s directly linked to human survival.
- Vital importance of health care gives this sector the potential for above-average financial returns.
- Many areas in the health care sector are dominated by a few big player.
- The health care sector includes drug companies, biotechs, medical device firms, and health care service organizations.
Economic moats in Health Care:
- High start-up costs, patent protection, significant product differentiation, and economies of scale. Patent rights, managed care organizations with large provider networks, or medical device firms with long clinical track records.
- Patent protection often prevents direct competition, so firms charge the highest price the market will bear for prescription drugs.
- Higher prices + economies of scale = gross margins ofter > 75% to 85%
- Barrier to entry: develop a drugs will take > 15 years, research, development and regulatory process and can cost hunderds of millions over that time frame.
- Pricing is often opaque to health care consumers and irrelevant to physicians helping make the decisions.
- Branded pharmaceutical companies generally boast top-notch profit margins.
- Most global pharmaceutical companies have returns on invested capital (ROICs) in the mid-20s.
- Gross margins often near 80%
- Operating margins between 25% and 35%.
- But innovation isn’t cheap. It takes money to make money, and the average cost of taking a drug from discovery to the pharmacy shelf is $800 million.
- The clinical testing phase (trials in humans) alone can take a decade.
- Drugs are discovered in many different ways.
- Drug development timeline: Preclinical Testing > Human Clinical Trials (Phase I) > Human Clinical Trials (Phase II) > Human Clinical Trials (Phase III) > FDA > To Market
- Generic drugs have the same chemical composition as brand name drugs but cost significantly less (40% to 60% less). They do not need to recoup the $800 million in per drug research and development costs.
- Drugs have been known to loss as much as 80% of their sales in the first six months after going off patent.
- Companies to provide stellar performance: blockbuster drugs, patent protection, full pipeline of drugs in clinical trials, strong sales and marketing capabilities, big market potential
Generic Drug Companies:
- Gross margins 40%- 50%
- Operating margins around 15% to 20%
- ROIC depending on the company’s exposure to branded drugs.
- Some competitive barries such as: 180-day of exclusivity marketing, which allows the generic company to cash in before others join the party.
- They seel to discover new drug therapies using biologic – cellular and molecular- processes rather than the chemical processes used used by big pharma.
- Categories: established, up and coming, and speculative
- Established: large number of drugs in late-stage clinical trials, plenty of cash on hand, plus cash flow to cover several years of research and development expenditures, salesforce of their own, a stock price that provides a margin of safety of around 30% to 40% to its fair value.
- Up and coming:
Medical Device Companies:
- These are the companies that make the hardware for medical procedures. There are two main types of device firms: cardiovascular and orthopedic.
- Barries to entry: economies of scale, high switching costs, and long-term clinical histories all serve as high barriers to new entrants.
- Patent protection on devices and instrumentation used for installation also provides a measure of protection.
- Each company makes its own proprietary set of tools that work exclusively with its own joint replacements, a surgeon who decides to use a different company’s artificial hip must squeeze in time to receive training on how to use the new instrumentation system.
- Finally, some device firms face less risk than pharmaceutical firms because product improvements tend to be evolutionary rather than revolutionary.
- Key factors we look for in a device firm:
- Salesforce penetration
- Product diversification
- Product innovation
Health Insurance/Managed Card:
- Less atractive because are subject to intense regulatory pressure and widespread litigation.
- How to find good companies:
- Effective medical cost management and underwriting
- Minimal dual-option business
- Large mix of fee-based business
- Minimal exposure to government accounts
Step 1. Forecast free cash flow (FCF) for the next 10 years.
Step 2. Dicount these FCFs to reflect the present value:
- Discounted FCF = FCF for that year / (1 + R)^N. R = discount rate and N = year being discounted.
Step 3. Calculate the perpetuity value and discount it to the present:
- Perpetuity Value = FCF10 x (1+g) / (R – g)
- Discounted Perpetuity Value = Perpetuity Value / (1 + R)^10
Step 4. Calculate total equity value by adding the discounted perpetuity value to the sum of the 10 discounted cash flows (calculated in step 2):
- Total Equity Value = Discoutned Perpetuity Value + 10 Discounted Cash Flow
Step 5. Calculate per share value by dividing total equity value by shares outstanding:
- Per Share Value = Total Equity Value / Shares Outstanding.