The last one year has been extremely brutal for pharma stocks. The Nifty Pharma index has crashed from 14021 to a low of 10354 in Feb.In June the index again came close to Feb lows. Now it has rebounded a bit to reclaim 11500.From all time highs to recent lows, the pharma index retraced almost half of its gains of the last 3 years. In absolute terms, the index is still down about 20% from the peak. These levels were first seen in November of 2014 for the index. Going into index constituents, the heavyweight stocks like Sun, Lupin are over 20% down from their respective all time highs. So should we write these stocks off? Is the party over for this sector? Or is this a great buying opportunity?
Looking at the past performance of the pharma sector, i will NEVER write off this sector entirely. One bad year is no big deal when the sector has been delivering mega-returns for over a decade.In last few weeks however, some of the beaten down quality pharma stocks have shown good rally from the lows triggered mostly by new drug approvals and also favorable observations from FDA observations of their manufacturing sites in some cases. Add this the strong 2000 point rally from the lows on the Nifty during which the big pharma stocks have done nothing. Odds seems quite favorable that what all could have gone wrong for pharma sector has already gone wrong and things will only get better from now for the investment-grade quality stocks. Even on charts, the pharma index looks set for an upward breakout above 12000, which may take it close to its all time highs again next year.
— Sumit Sethi (@Sethinomics) September 30, 2016
So now let me come to the important part. How can a small investor with limited resources and often with no specialized knowledge of medicine identify mega-wealth creator pharma stocks?
Here is how i did it and ended up with stocks like Ajanta Pharma that gave me 5X returns in under 3 yrs and largecaps index stocks like Lupin and Aurobindo which doubled under two yrs.
- It’s obvious that if a company is growing its profits continuously, stock price will also go up. The faster the profits grow, the faster the stock will go up.
- In mega bull markets, stocks that have gone up a lot in the past can always go up a lot further too as in the case of the above mentioned stocks where i was by no means a trailblazing discoverer but still made returns that beat the markets massively.
- Pharma being a heavily regulated sector, it is important to invest only in the companies known for high promoter integrity. Companies in the dock with regulator because of their dubious manufacturing practices are a complete avoid for me.
- All managements talk of a great future ahead. I tend to trust only those who have a proven track record of past performance.
- I avoid companies with poor financial management which have high debt/equity, low RoE & RoCE. There are too many gems in pharma industry to waste time & money on poorly run businesses.
- Ideally, a pharma company that has been around for over a 15-20 yrs should be almost debt free or else they are not doing it properly.
- So many pharma stocks have been mega-baggers while maintaining negligible debt.This business is more about capability than about leverage.
- Return of Equity and Return on Capital Employed are excellent mathematical expressions that i use to measure & rate competence of my stocks. Most of my pharma stocks have average RoCE of over 20% in trailing 5 yr periods.
- There are some stocks where the earnings speak for themselves and then there are others, where managements keep coming up with excuses.
I continue to believe that if one invests rationally, pharma is one of the best sectors for long term wealth creation along with autos and financials.
Disclaimer- Views biased. We have holding in several stocks in pharma sector. This doesn’t constitute investment advice.