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Why I’m Buying Gilead And Selling Celgene

Summary Gilead appears very cheap compared to Celgene. In this article I compare growth expectations to valuation for the two companies. I think that a “pair trade” long Gilead and short Celgene makes sense at this time. Today I am starting a new mock portfolio on Seeking Alpha: the Pairs Trade Portfolio. Every transaction made in the portfolio will be a pair of trades of equal value (as close to $20,000 for each stock as can be), one long trade and one short trade. I plan on adding to this portfolio – and readjusting as necessary – over the next months and years and it will probably end up being a rather large study. The first trade is to go long Gilead (NASDAQ: GILD ) and short Celgene (NASDAQ: CELG ). My apologies for the length and description of this article. As it is the first in the series I will define and describe the strategy of pairs trading in detail here and refer to this page in future articles. Those readers familiar with the concept can skip over the next part and begin reading at the “Gilead vs. Celgene” section below. What is a “pair trade” and why would an investor want to do it? Pairs trading takes two highly correlated investment instruments and essentially pits them against each other. What stock will do better, Lowe’s or Home Depot? Pfizer or Merck? The investor goes long on the stock he/she thinks is undervalued relative to the overvalued one. The (relatively) overvalued one gets shorted. The investor is thus hedging bets and isolating a trade that only takes into account the relative value between two stocks. The strategy is often thought of as a very technical, statistics-driven exercise in which an outperforming stock is always shorted and the underperforming one is always the long. “Reversion to the mean” is counted on to make money in the pair trade. However, I feel that approach is short-sighted and I won’t be a slave to it. There are countless examples of stocks that outperform others consistently despite a high degree of correlation in the short term. Those are cases in which a pair trade with the underperforming stock as the long should be avoided. The motivation for making a pair trade is largely due to the fact that the strategy is a market-neutral hedge. It does not matter if the overall market crashes or zooms to new heights; the investor makes money if and only if the long stock pick outperforms the short stock pick. For example, let’s assume we set up a pair trade that is long Gilead at $100 per share and short Celgene at $120 per share and a market crash hits us in 2014. At the end of 2014, Gilead sits at $60 per share and Celgene goes to $60 as well. If the original position was $20,000 in each stock, then our pair trading investor has made $2,000 during 2014 (long GILD loses $8,000, short CELG gains $10,000) – a gain of 5% overall. Pairs trading is potentially a great defensive strategy. The market-neutral aspect of it makes it something to consider when it appears that stocks are overvalued in general. Pairs trading protects the investor from high valuations. Here’s a simplistic example: an investor believes that company A is a great company in a great industry. He/she really wants to invest in company A but the market is in the stratosphere and A sports a P/E of 70 – the risk seems to outweigh the reward. But he/she sees that company B, which has similar prospects to company A has a P/E of 110. The investor can go ahead and invest in company A as a pair trade with B and those P/E ratios might as well be 7 and 11, or 700 and 1100 for that matter. Recently I hear a lot of statements like “there’s nothing to buy”, “money has to be invested somewhere”, or “I’m afraid of valuations, but I don’t know what else to do but buy and hold.” At this point in time, I feel that every investor should consider any and every conservative strategy available. In my opinion, the US markets are in for a correction and I have written about the macro outlook a couple of times recently: One could think of a pairs trade strategy as another “what to do” when a bear market looks likely. Gilead vs. Celgene Both Gilead and Celgene are large biotech companies (market caps of about $157 billion and $96 billion respectively) and therefore it is not surprising that the correlation between the stock prices of the two companies was high during the past year: GILD data by YCharts A major divergence occurred recently – in early November – when Gilead started drifting lower/sideways while Celgene powered higher. On December 22, GILD took a fairly large plunge when Express Scripts (NASDAQ: ESRX ) announced that it would exclusively cover the AbbVie (NYSE: ABBV ) hep C drug. The question is, does that divergence mean that Gilead is undervalued compared to Celgene? The above chart suggests that might be the case and a further look is in order. I think that GILD is a better buy than CELG and the next sections will cover the growth prospects and valuation comparisons. Growth for Gilead The average analyst estimate for sales growth in 2015 is 17.8%. A quick look at where that growth will come from is in order to see if it makes sense. Estimates for worldwide growth in Sovaldi/Harvoni sales in 2015 are all over the map and while it is certainly difficult to guess where that will land, I’d say a conservative estimate is for 5% growth in sales. I’ve seen estimates from -5% to 30% growth. Sovaldi/Harvoni will likely account for more than half of Gilead’s total sales in 2015, but other drugs are growing fast and becoming more important for the company. In a previous article about Gilead, I noted that: According to Thomson Reuters, sales of idelalisib [Zydelig] are forecast to exceed $1 billion by 2017, with consensus sales forecasts of $1.218 billion that year. Zydelig began sales last quarter and it will be interesting to see how well it did in Q4 2014. It should add somewhere between $500 million to $700 million in 2015. In my article referenced above, I also singled out Stribild and noted that it was expected to see sales of over $2 billion in 2016. In 2014, it should easily clear the $1 billion mark. Like Zydelig, Stribild should also add a considerable amount to the top line. My estimate is an additional $700 to $900 million in 2015 sales. Complera/Eviplera is another in Gilead’s best-in-class HIV stable of drugs that is growing fast. In the first nine months of 2014, sales grew over 60% year to year and will eclipse the $1 billion mark for all of 2014. I expect it to add $500 to $600 million in sales to 2015 figures. A look at Gilead’s most recent 10-Q (see part 13. Segment Information) shows that the other drugs will likely be slightly up or slightly down. Add in any new approvals and there should be slight growth in the “other” category of those products that I did not mention above. Adding everything up (and making some assumptions for Q4 2014) puts my rather conservative 2015 revenue growth at about 12% – 14%. So by my back-of-the-envelope reckoning, the analyst expectations for 17.8% revenue growth look reasonable to me. Growth for Celgene Celgene’s growth is much easier to estimate as the company just gave guidance yesterday. Management expects 2015 revenue to grow 22.3% over 2014. Analyst estimates show a number of 21%, so it looks safe to assume something in the low 20s. Valuation I have recently written about Celgene’s GAAP and non-GAAP reporting in an article titled ” Celgene: Could You Be More Like Gilead, Please? ” and because I believe that the non-GAAP numbers inflate EPS, I will use GAAP figures for the P/E calculations below. Gilead should report EPS of about $7.25 for 2014. At a current stock price of $104.80, that equates to a P/E of 14.5. Celgene has reported EPS of $2.39 for 2014. At a current stock price of $119.16, that equates to a P/E of 49.9. Let’s take a look at cash generation: GILD Cash from Operations (TTM) data by YCharts Gilead’s market cap is about 60% higher than Celgene. However, it generates more than 300% cash than Celgene. The above chart shows the trailing 12 months, so once Gilead’s Q4 results are put into it, the figure will likely be something like 400% more cash from operations. Finally, a look at revenue: GILD Revenue (TTM) data by YCharts Again, Gilead’s soon-to-be-released Q4 results are not included. Once they are, the TTM sales number should be around $23 billion, or 200% higher than Celgene. Conclusion When we look at sales, earnings, and cash flow, we can see that Gilead is at a level anywhere from two to four times higher than Celgene. And yet the market cap of Gilead is only 60% higher than Celgene. 2015 growth estimates favor Celgene by 22.3% to 17.8%. Gilead’s incredible growth in 2014 will plateau and we will see good – but not exceptional – growth in 2015. For that reason, Celgene clearly does deserve a higher multiple, but not a multiple that is more than three times that of Gilead. I expect to see the difference in multiples between the two stocks narrow, thus favoring GILD in a pair trade. The Portfolio So here is what the mock portfolio looks like so far after executing the first pair trade: (click to enlarge) Not terribly exciting yet, but there will be more to come. Be sure to click “follow” if you would like to get real-time alerts on my future articles. Disclosure: The author is long GILD. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

When The Dollar Crashes

Editor’s note: Originally published on January 26, 2015 Back in late April of 2011, legendary investor Jim Rogers made one brilliant call combined with one incredibly stupid observation. So he was hitting about 50%. That’s not bad, the very best prognosticators rarely do better than getting it right 65% of the time. Most people get it dead wrong most of the time. Speaking of silver on April 20, 2011, Rogers was quoted as saying, “If silver continues to go up like it has been over the past 2 or 3 weeks, yes, then it would get to triple digits this year. And then we’ll have to worry. It’s not parabolic yet”. Rogers concluded silver wasn’t yet in a bubble. That may well turn out to be one of the very worst predictions Jim Rogers ever made in his life. A week later, on April 28, silver peaked at just a smidgen under $50. In two weeks, by May 12th, silver dropped by an incredible 33%. But Rogers got one thing dead right when on April 20th, he said, “A parabolic move and all parabolic moves end badly.” Silver went parabolic and Rogers couldn’t look at a chart and recognize a parabolic move when it stared him in the face. He knew enough to understand the effect of a parabolic move; he just didn’t see it in front of him. If you want to retire rich, go to a tattoo parlor and have them inscribe on your forehead, in reverse writing, “ALL PARABOLIC MOVES END BADLY.” In the same way that people tend to think in absolutes about politics, either you are a Republican or a Democrat; investors want to think in terms of either Technical Analysis or fundamentals. That tends to suggest there are no other alternatives in either politics or investing. I don’t know a single investor made rich by either TA or fundamentals. Maybe they work for some, some of the time. I’ve just never seen it. In April of 2011 silver went parabolic. At least to those who were capable of recognizing a parabolic chart in front of them. There were probably 100 fundamental reasons to buy silver. TA suggested silver was headed to the moon. Both were wrong. There are 100 reasons to buy a commodity, any commodity, at every top. And if you actually believe TA is valid, invert the chart and see what is suggests then. That’s what Warren Buffett did before rejecting TA as an investment guide. The investment psychology as measured by the bullish consensus toward silver in April of 2011 was higher than it was at the very top of silver at $50.25 in late January of 1980. And silver went parabolic. ALL PARABOLIC MOVES END BADLY. I was working on a piece for Friday, last week, and I needed to know what the Dollar Index was doing. I pulled up a chart and saw that the Dollar Index was up a remarkable 2% for the day . It actually went above 2% during the day but I couldn’t capture it on a screen print. I did capture the 2% move and used it in a piece. 2% in a day is a lot in any currency much less the Dollar Index. For one reason or another, I watched again on Friday to see what the Dollar Index would do. Between Thursday and the high on Friday the 23rd of January the Dollar Index climbed a remarkable 3.25% in 36 hours. I’ve never seen such a move in a currency. No one that I know saw that or at least no one remarked on the move. So I went back to the piece I wrote about silver on April 25th of 2011 and looked at the chart I had posted of silver where I claimed, “Silver is going parabolic.” I took a lot of flak at the time in 2011 because all the silver clowns were convinced silver was going to $500 an ounce overnight. I was right, they were wrong. Silver went parabolic and then crashed in two weeks by 33%. About five guys got it dead right in April of 2011 and everyone hated them for it. A 3.25% move in any currency is a parabolic move. It is the kind of move that ends a trend, no matter up or down. There are a hundred fundamental reasons to buy the dollar right now. TA suggests the Dollar Index is going to 125. Everyone loves the dollar. The bullish consensus on the Dollar Index is the highest in recorded history. That is what marks tops. ALL PARABOLIC MOVES END BADLY. Black Swan events are those hard to predict and rare events that are beyond the realm of normal expectations. Parabolic moves may not qualify as in the realm of normal expectation but that doesn’t mean you can’t recognize them in front of your nose. The dollar index will crash one day. It won’t be down 33% in two weeks similar to that move in 2011 in silver. But the Dollar Index could be down 1/3 of the move since July of 2014 in as little as two weeks. The index was around 80 on July 1st and rocketed higher to 95 last week. I can see the dollar dropping 5 points in two weeks. Wouldn’t everyone be shocked?

5 Smart Beta Predictions For 2015

January brings plenty of resolutions along with forecasts. I’ll spare you the details of my renewed commitment to kale and cardio fitness and instead focus on what the year ahead could look like for one of the most talked about investment ideas ― smart beta . Investors and advisors alike are becoming intrigued with an approach that combines elements of passive and active investing and can potentially outperform a typical index strategy. It’s a different way of thinking about investing, focusing on the true drivers of risk and return and putting them together in a way that’s designed to create better outcomes. Here are my top five predictions for smart beta as it continues to mature in 2015: Less arguing, more action At the last industry conference I attended, I counted six (six!) different panels on the topic of smart beta. That’s the great news. The bad: Almost every panel and press article gets mired in a discussion of the name—Do you like it or hate it? Is it always smart? Is it really beta? Enough already! This pedantic focus on the name distracts from the fact that smart beta might just be one of the most meaningful developments in the investment landscape of this decade. So let’s stop arguing over whether or not it’s “smart” or whether or not it’s beta and start talking about how it has the potential to improve investment outcomes. This year, I predict we’ll see more agreement on common classifications for the category that describe how different types of smart beta can serve different purposes. This will help investors compare and contrast smart beta strategies and the role they might play in their portfolios. Smart beta gets some respect Along with ceasing the name game, I’d also like to call a halt to the active/passive debate. Purists would argue that smart beta is neither active nor passive—and I’m inclined to agree. It’s simply smart beta—including elements of both active and passive investing. This year, I predict that investors will increasingly recognize smart beta as its own asset class and consider an allocation alongside their existing active and passive investments. Moving on to SB 2.0 The earliest and most widely adopted forms of smart beta have been equity index portfolios that are weighted by factors such as price to earnings or dividend yield, rather than by traditional market capitalization. While these index-driven strategies, often delivered in the form of exchange traded funds ( ETFs ), can help enhance returns or reduce risk, smart beta doesn’t end there. How can we deliver exposure to a particular asset class in a way that improves diversification and risk adjusted returns, or takes advantage of known market anomalies? This is smart beta. This year, I predict investors will continue to embrace equity index versions of smart beta, while also exploring the potential for more outcome-oriented strategies in other asset classes. Which brings me to prediction number four… Joining the hunt for yield The search for yield is perhaps the biggest challenge investors face in today’s interest rate climate. Reaching into longer dated securities to boost income is increasingly difficult to stomach, even with Federal Reserve Chair Janet Yellen promising to keep interest rates low for longer. Traditional fixed income indexes are currently biased toward longer term bonds, a bias that can hurt investors if rates rise, and have the largest exposures to companies or countries with the greatest amount of debt, potentially increasing credit default risk. Yet, simply reducing duration or credit exposure could erode the yield that investors so avidly pursue. One way to diversify traditional fixed income investments is to consider strategies that shift away from highly indebted companies and offer a balance between interest rate and credit risk… while still providing an attractive yield. This year, I predict that we’ll hear a lot more about smart beta in fixed income as an attractive alternative to traditional passive bond indexes. (I’ll discuss fixed income smart beta in more detail in my next post.) The resurgence of Min Vol Minimum volatility strategies were among the most popular forms of equity smart beta that attracted fervent attention in the wake of the credit crisis. Minimum volatility strategies seek to decrease the effects of the market’s ups and downs over time by providing equity investors lower risk alternatives to traditional equity portfolios. These funds enjoyed a rapid rise in fame, gathering an estimated $9.1 billion in net ETP flows in 2012 and 2013 ( Source: Bloomberg) . Since then, attention has waned. After three consecutive years of double-digit equity market returns ( Total gross return for S&P 500 Index from 12/31/2011 – 12/31/2014) there was less focus on the need for downside protection. However, over the last several months market volatility has returned with a vengeance—a function of changing monetary policy in the U.S. and a plethora of geopolitical risks popping up around the globe. In this environment of increased uncertainty, I predict that minimum volatility strategies will re-enter the spotlight as a way for investors to maintain equity exposure while seeking less risk. Original post