We often turn to my five rules for tech investing success to see which stocks to buy.
But those same rules will also help you figure out which “turkeys” to avoid.
That’s a critical part of the game. Because in investing, “job one” is to make sure you live to trade another day. So a huge part of your long-term success comes down to not losing money in the first place.
I wanted to talk with you about this today because I’m picking up a ton of online chatter claiming that a certain pharmaceutical stock has become a screaming bargain.
And sure, it sounds like a bottom-feeder’s dream come true. Since its Aug. 5 high, the stock has dropped more than 65%. If it regained just 69% of its previous high, it would double.
But don’t believe the hype.
I ran this stock through the five rules in Your Tech Wealth Blueprint, and what I saw was a deeply troubled company you should stay well away from.
The Stock That Fell to Earth
Sometimes the best trades are the ones you never make.
That’s certainly true of Valeant Pharmaceuticals International Inc. (NYSE: VRX).
On the surface, Valeant looked like a good bet. After all, you’d be hard pressed to find a higher flying company.
The Canadian firm used its expertise in skin, stomach and eye health to garner sales of $8.25 billion last year, more than double the $3.5 billion it earned in 2012.
Not surprisingly, the stock shot up to reflect that massive growth.
Until its sudden fall from grace on Aug. 5, the Valeant had soared some 174% in just two years, beating the S&P 500 Index by 634%.
But Valeant may have flown too close to the sun…
To begin with, the company depended for much of its sales on an alliance with Philidor Rx Services LLC. In a practice that departed from industry standards, the “specialty” mail-order pharmacy basically only filled prescriptions with drugs made by Valeant.
And Valeant now faces accusations that it used Philidor to avoid scrutiny over drug prices from health insurers so that it could keep profit margins artificially high.
Let me be clear on something: No one at Valeant or Philidor has been charged with criminal wrongdoing. But this is definitely a messy corporate scandal that raises disturbing questions about Valeant’s business practices.
Now then, I’m aware that many speculators are drawn to just this sort of distressed stock in the hopes that it’s greatly oversold.
So, to help you determine if this is indeed a “special situation” worth considering, if only for the high-risk portion of your portfolio, let’s run Valeant through the five filters of my tech investing system.
Rule No. 1: Great Companies Have Great Operations
You’ll find your best returns with well-run firms with top-notch leaders.
Just on this aspect alone we’d have to give Valeant a failing grade. It has two black marks against it.
First, CEO Michael Pearson is credited with building Valeant into a growth machine. But his judgement and business practices have come under intense scrutiny.
Second, his company has become an industry pariah. Last month, Valeant disclosed that federal investigators are probing the company’s sales and distribution practiceswith the Centers for Medicare & Medicaid Services.
These accusations alone call the company’s core operations into question, along with the steadiness and integrity of its leadership.
Rule No. 2: Separate the Signals From the Noise
To create real wealth, you have to ignore not just hype put out by this or that company, but also the noise you hear so often on Wall Street.
In this case, the noise is so loud that it’s hard to get a clear sense of what’s really going on with Valeant. Yes, the company has ended its relationship with Philidor, but we can’t at this time assess the impact that move will have on the company’s growth and bottom line.
Valeant’s defenders and critics are battling it out in the media.
In fact, Warren Buffett’s vice chairman, Charlie Munger, has accused Valeant of being “too aggressive in ignoring moral considerations in the way it did business.”
Public displays of this kind are never good for investors trying to sort out fact from fiction.
So, until we get a report from an independent third party about Valeant’s business practices – that is, until we get some good clear signals – we can’t determine just how much value is there.
Rule No. 3: Ride the Unstoppable Trends
Look for stocks in red-hot sectors. As those stocks ride the trend higher, they’ll offer you your best chance to reap market-beating gains.
There’s no question that Valeant is in a high-growth sector. The biopharmaceutical industry has a huge pipeline of new drugs with high profit margins. And because of their patents, many companies in this industry are protected from competition.
And that’s not all.
Obamacare is adding millions of people to insurance rolls, boosting drug demand. And the presence of 76.5 million aging baby boomers almost guarantees high sector growth for years to come.
So, we’d have to say Valeant clears the bar for that rule. So the question becomes: Does the sector’s huge potential make up for Valeant’s other deficiencies?
I do not believe it does.
Rule No. 4: Focus on Growth
Companies with the strongest growth rates almost always offer the highest stock returns.
At first glance, Valeant appears to have this rule locked up. Over the past three years, it has grown its sales by an average of 50%, which means that sales double roughly every 18 months.
But remember, we’re basing that projection on past performance that made Valeant the darling of Wall Street. We simply can’t predict how well it will do in the future now that it has ended its alliance with Philidor and is looking for new, untried sales channels.
And as tech investors, we always want to be able to predict future growth as accurately as possible.
Rule No. 5: Target Stocks That Can Double Your Money
This is where we look at Valeant’s earnings growth and see how long it will take the firm to double profits. By doing that, we can figure out how long on average it should take for the stock to roughly double in value.
Once again, the serious uncertainty surrounding Valeant makes it difficult – if not impossible – to project future earnings.
Now, turnaround investors might be tempted to take a run at the stock because it’s 65.5% below its record high. If it regained just 69% of that price we’d have profits of more than 100%.
However, after considering all the factors working against the stock, I see that scenario as pure speculation.
Stuck in “No Man’s Land”
The company has not announced anything approaching a true turnaround plan, and we don’t even know how long the current CEO will be on board.
What my five rules tell us is that Valeant doesn’t fit into any single, clear profitable investing category.
It’s neither a solid foundational play, nor a true growth stock.
And as you’ve just seen, at this juncture it’s a poor candidate as a special-situation play.
So, until a clearer story about Valeant emerges, and we get our hands around some good, hard numbers, I would avoid this stock.
Instead, I would devote your hard-earned capital to a play that meets our tech-investing criteria.
In fact, I have one for you. It even happens to be a pharmaceutical company.
But unlike Valeant, this company is led by one of the sharpest CEOs in the game.
What’s more, the company stands at the pinnacle of one of the hottest sectors in the world. I recently ran the numbers for this stock, and I believe this outfit is poised to capture more than $29.78 billion in new revenue by 2018.
It achieved this dominance through shrewd leadership, deep pockets, mature, worldwide distribution networks and a wide “moat” around operations.
This company is rock-solid from an earnings standpoint as well and has proven it can grow earnings faster than sales.
But I think what I like most about this firm is that it’s a great safety play in this volatile market.
This firm pays a dividend of 3.63%, the kind of high yield in a low interest-rate environment that gives you built-in stability.
I can’t go into the whole story here, but I have prepared a special briefing that runs through the whole investment case for this firm.
You can find out how to access a copy by going here.