CONCLUSIONES Y ALTERNATIVAS Conclusiones Generales Conclusiones Generales

Because a pharmaceutical company’s operating performance is determined largely by the success of its drugs and drug candidates and may often be influenced only marginally by general industry trends, stock picking is of the utmost importance. The stocks of companies that generate top-line surprises and positive clinical news flow usually tend to outperform the industry. Even so, it is advisable to spread pharmaceu- tical investments over a number of stocks so as to minimize idiosyncratic risk. Even the best-managed and best-positioned company is not immune to the risk of extreme events that are impossible to foresee or hedge. Such events can entail extremely large cash outflows and can severely dent a company’s profitability for extended periods.

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Examples include, but are not limited to, supply disruptions, the emergence of safety concerns in relation to a large product, the failure of high-profile pipeline compounds, product liability suits, and litigation of marketing practices. True “hedges” are rare, in the sense that it is often impossible to identify companies that would benefit directly and proportionally from a competitor’s setbacks, suggesting that diversification is often the only viable strategy to reduce stock-specific risks.

It is worth noting that the heterogeneity of the industry, where fundamentals are concerned, also extends to the characteristics of pharmaceutical company shares. The listing currencies of the largest stocks include the USD, EUR, GBP, CHF, DKK, and JPY, which further complicates hedging decisions. Size differences can also be extreme. For example, the market capitalization of each of the five largest compa- nies exceeds $100 billion, but there is an abundance of small and midsize compa- nies valued at mere billions, hundreds of millions, and even millions of dollars. This fragmentation reflects the high barriers to entry into any one segment of the phar- maceutical industry; many biotechnology players are one-product companies that own the intellectual property to a specific molecule, which prevents their larger peers from developing the same molecule and putting them out of business.

In light of the pronounced impact that such product-related news flow as clinical data and regulatory approval decisions may have on a company’s future profitabil- ity and investor sentiment, an understanding of key upcoming catalysts is a prereq- uisite for well-informed investment decisions. Uncertainty with respect to both the timing and the outcome of any product-related news flow is one of the main chal- lenges of investing in pharmaceutical firms. Companies often provide a rough guide to the expected timing of news flow; for example, they might communicate that headline results from a phase III trial are expected in the second quarter or second half of the year. It is rarely possible to specify the month, let alone the day, when key news flow is expected. Consequently, it is often virtually impossible for investors to avoid exposure to news-flow risk when taking positions in pharmaceutical stocks. The likelihood of success may be even more difficult to predict than the timing. Many analysts and investors avidly study the publicly available clinical data, trial design, and historical precedents to gain a better understanding of the potential pitfalls; however, there are no crystal balls to predict the outcome of any one event.

Consequently, short-term trading strategies are often fraught with risks. Longer- term investment decisions should ideally be based on a high level of comfort around the totality of the news flow to be expected over a time horizon of 12–18 months. There are no compelling reasons to shun stocks that are devoid of large individual catalysts. In fact, stocks with a large number of expected news-flow items that may not be transformational in and of themselves but have the potential to drive longer- term consensus earnings upgrades and to positively affect sentiment may offer an attractive risk–reward profile.

However, caution is warranted in the case of upcoming catalysts related to proj- ects that are advertised as “free options” by the sell side. Although many analysts may prudently refrain from including the potential upside in their forecasts, it is often included “in the whisper.” By the time a sufficient number of investors have taken positions to benefit from the potential upside, enough of it is priced in to trig- ger a negative share price reaction in the event of failure, whereas the rally to be expected in case of success may be limited. A particularity of the pharmaceutical industry is that news flow without the potential to influence near-term forecasts may still trigger significant share price reactions. For example, a stock may rally on the announcement of positive phase III data for a potential blockbuster drug candi- date, even though the achievement of peak sales may still be more than five years away and the drug may not break even until one to two years after the launch.

The relatively modest impact of industry trends on companies’ operating perfor- mance largely precludes trading strategies centered on quarterly earnings releases. A firm’s operating margins primarily reflect the growth trajectories or decay curves of its most profitable assets (i.e., their stage in the product life cycle) and the timing of major expense items, which is largely discretionary. With the industry’s rising exposure to emerging markets, where business may be more tender driven and conducted in a large number of different currencies (many successful drugs are sold in more than 80 countries), even the top line is increasingly difficult to predict. (Note that US sales of key drugs can usually be forecasted fairly accurately owing to the wide availability of weekly and monthly prescription data.) An earn- ings “beat” or “miss” is thus not necessarily indicative of a change in company fun- damentals; it may simply reflect fluctuations from one quarter to another. Rarely is there a significant “read-across” from one company’s set of results to those of its peers reporting later.

Pipeline news flow represents a risk with respect to earnings releases to the extent that the release contains a pipeline update and may, on balance, be slightly more neg- ative than positive. The reason is that the results of pivotal trials are seldom commu- nicated in the context of earnings releases. Headline results are usually announced by means of a press release as soon as they become available, whereas the presenta- tion of details must often await a medical congress that may take place many months later. Medical congress rules typically prevent company management from divulging any further information ahead of the event. At best, a company may announce posi- tive internal decisions about its pipeline, such as phase III transitions of drug candi- dates. An important corollary is the possibility that the termination of development programs or other negative news may be announced in earnings releases.

Although divergent share price performance may be more common and more pronounced in the pharmaceutical industry than in other industries for the reasons mentioned, there have been extended periods when stocks have moved as a group,

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often linked to industry rotations coupled with a news-flow void. Owing to their relatively pronounced lack of cyclicality, pharmaceutical stocks are perceived as defensive in the classical sense (i.e., as offering relatively low beta). (As discussed previously, pipeline failures and various issues that may arise with respect to a com- pany’s current operations have the potential to send individual stocks plummeting. In the latter part of the last decade, many of the majors suffered a string of setbacks, prompting some investors to exclaim, “This industry is not defensive!”)

Because cash flows are relatively stable and predictable during the exclusivity periods of key products, many companies offer generous dividend payout ratios and have adopted a progressive dividend policy. Therefore, rotations into the phar- maceutical industry may at times be driven by considerations relating to dividend yields. Although the rewards for successful stock picking may vary as a function of the market environment, it appears intuitive that a lack of due diligence with respect to any pharmaceutical investment invariably entails severe risks to the per- formance of a portfolio.