The Sick Economist's Blog, page 16

BIOTECH: A SHELTER FROM THE STORM?

In what may be the worst stock market crash of our lifetime, biotech stocks are holding up surprisingly well. This may seem counterintuitive, as biotech has traditionally been regarded as a risky sector, for bold investors only. Is this relative safety a new paradigm, or just a fluke? Are biotech investors “in the clear?” or is the worst yet to come?

Truth be told, stock market crashes and financial panics are interesting. Unfortunately these incidents are interesting much the same way that a car crash is interesting. Equal parts revolting, terrifying and interesting. Mostly interesting as long as you are not the one locked in the car that is being crushed to pieces. Each crash scene has a crime scene investigator. This detective arrives on the scene for two reasons. Yes, her job is to figure out what went wrong, and assign blame if appropriate. But, more importantly, she seeks to collect data to share with the public, so that similar accidents can be avoided, or reduced, in the future. Let’s investigate with an eye towards preventing future carnage.

One surprising element of our current national catastrophe is that biotech stocks remain relatively unscathed from the worst of the financial trauma. As of the writing of this post, the $SPY exchange traded fund, which represents the biggest, most blue chip, most established names in American Business, is down 22.9%.  While the $XBI, which represents a basket of biotech stocks, both large and small, is only down 17.6%.  Now nobody likes to lose 17%, but that kind of drop would only register as a blip for most seasoned biotech investors, who are used to huge price swings and constant volatility.

How could a basket of risky, often unprofitable, companies possibly be looking more stable than the largest behemoths of corporate America?

Is this sustainable?

The answer comes down to the following question, “What makes a good business in troubled times?”   Ironically, some of the hallmark characteristics of biotech actually look quite promising during economic uncertainty. Let’s explore.

Will Demand Hold Up Under Pressure?

“Under Pressure” isn’t just a catchy tune by 70’s rock legend Queen. “Under Pressure” is the new lifestyle for the American corporate executive. All kinds of people who previously thought their business addressed a very steady market are finding their customers evaporate overnight. Some of this pain is very particular to the Covid-19 crises (death cruises and empty hotels come to mind). Other shriveling markets are just due to the psychology of fear that takes hold during an economic free fall. Even when people can go back to the mall (whenever that will be) they may be scared to spend money on consumer luxuries. A good deal may never go back to the mall again, now that they have grown comfortable shopping from home.

So, the S&P 500 is forced to endure a double whammy. The decimation of demand for entertainment experiences, and some very shaky long term prospects for consumer luxuries, both large and small (no new cars for a while, certainly no expensive clothes or jewels).

Health and survival, on the other hand, clearly remain paramount for the majority of Americans, and evidently most of the world. We have gone to extreme lengths (potentially destroying our own economy) in order to preserve health. Along the way, the Media has emphasized themes such as rapid innovation, “outside the box” thinking, and perseverance in the face of great challenges. All of these elements dovetail nicely with the biotech process, the biotech ethos, and hopefully, life saving outcomes.

Clearly Americans are willing to give up a great deal to remain healthy.

 

Can The Customers Pay?

A very large number of formerly rock solid businesses are going through crisis not because clients don’t want to pay, but simply because clients can’t pay. Very few shopkeepers or homeowners default on their mortgage because they want to be evicted. A major cash flow crisis has decimated millions of Americans’ ability to pay even for critical services.

Who have we turned to during these times of panic?  Uncle Sam. As of the writing of this post, congress approved a 2 trillion dollar rescue package, an unprecedented government intervention in American history.

For years and years, the biotech sector suffered due to the perception that the business was too dependent on the government. Too dependent on approval from government bureaucrats, too dependent on legislators that might abolish the current healthcare system, too dependent on Medicare and Medicaid agencies that might pay high prices for drugs, or might not.

Suddenly, like a lightning bolt out of the blue, biotech’s largest liability is it’s strongest asset!  Suddenly, Uncle Sam is seen as the only large player who can reliably pay his bills. In this light, businesses that depend on government payers are like lifeboats on the Titanic; rare, sought after, and not enough to go around for everybody.

The current crisis also seems to neutralize the largest single boogeyman for biotech stock prices: the threat of radical health reform. If we have learned one thing over the last decade of constant partisan battle over Obamacare, it is that health reform is a demanding work out for politicians, with high political risks and costs all the way around.  Right now, almost every governmental participant, on each side of the political aisle, has her hands full with pressing issues of day to day survival. Radical healthcare reform will have to wait for another day. Another day long into the future. This is very good for biotech.

The last reason why biotech can look forward to some very willing and able clients is a sea change in attitude that is being forced by the current crisis. Instead of constantly attacking “greedy” pharmaceutical companies for high prices, the Media has taken to constantly praising brash pharma innovators as “our best hope.”  For years and years, pharmaceutical execs were cast as the “bad guy” by a Media constantly looking to assign blame. Now, suddenly, pharma executives are knights in shining armour.

Even the attitude towards payment itself may change radically. One part of the biotech controversy was the fairness of high prices. But another part of the debate was simple affordability. The Media never tired of trotting out dire statistics about how soaring medical costs were about to bankrupt America.

As of March, 2020, we are about to find out, once and for all, if Uncle Sam can ever go bankrupt. Most the multi-trillion dollar rescue package approved by congress will be fantasy money that the Fed creates out of thin air. We are about to print trillions of dollars without even bothering with the actual printing process. If this harrowing experiment is successful at all, questions of affordability will be settled. Many biotech outfits will serve a market where the single biggest client has an unlimited bank account. Doesn’t that sound like a good market?

 

Can The Product Be Delivered?

If you have willing clients who can pay your price, then the last relevant question is: can you produce the goods or service?  The way the current crisis has unfolded, the vulnerability of our highly globalized supply chain has been laid bare. If workers in China are sick, they can’t make your product for import to the USA. Even once those Chinese workers get better, our delicate web of international logistics has been shredded by a viral chain reaction.  Companies that make cleaning and sanitizing products should be earning a fortune right now. But many are not. Just because they have someone willing to pay for the product does not mean they can actually make the product.

Biotech, as a sector, has a lot less of this particular problem.  Altogether, many biotech medicines are not even made by people, they are made by genetically altered bacteria!  While some pharmaceutical production has been hindered by a lack of basic materials being imported from China, this problem mostly applies to manufacturers of low value, generic drugs. Most biotech companies listed in the $XBI fall into one of three buckets.

First, many publicly listed biotech companies don’t even have an approved pharmaceutical in production yet. They generate value for shareholders through the advancement of intellectual property and patents. There are no components or materials to physically move, so value cannot be destroyed by logistical shocks.

Second, for many biotechs that do manufacture and market drugs, the manufacturing process is simple. What was tough was pioneering the intellectual property that makes the pharmaceutical possible. Thus, minimal problems are caused by a wounded logistics chain.

Lastly, for some biotech concerns, the manufacturing process is very complicated, costly, and demanding. So demanding, in fact, that they never were able to outsource manufacturing to China. Many biotech products are created using special bacteria, or highly proprietary processes that no executive ever would have wanted to send to China. For these businesses, almost nothing has changed despite a crisis that has shaken the world’s economic foundations.

 

Tactics & Strategies

After analyzing the factors discussed above, we realize that we could be entering a golden era for biotech investors. That being said, not all biotechs are created equal. Those that do not have strong capital reserves or strong financial backers could wind up being blown away in the hurricane. Below are some ideas to weather the storm.

If you don’t have time or confidence to do the research, stick with exchange traded funds. $XBI, $IBB, $FBT should give you robust and broad exposure to the sector.
Favor names doing essential research for broad diseases. The trend over the last few years has been to focus on rare diseases. That trend may now be reversed. When money is tight, or Society has entered crisis mode, the greatest good for the greatest number of people becomes the imperative. Focus on research that saves highly visible lives. Some ideas could be $MRNA, $AMGN, $CELG, $BIIB
We may be entering an era of renewed focus on infectious disease. These names were out of vogue for the longest time. Curing and preventing infectious disease may suddenly seem much higher priority for the Powers that Be. Some ideas could be: $ADMA, $VIR, $INO
Focus on biotechs with strong funding in place. It may be all but impossible to raise fresh funds over the next 24 months. As they say, “cash is king.” Biotechs with strong cash reserves are: $GILD, $CRSP, $VRTX

 

Smooth seas never made a good sailor. But choosing a sturdy craft to start may be a wise move. Biotech may well be just the vessel you need to ride out this stock market storm.

 

 

DISCLOSURE:  The Sick Economist owns $GILD, $ADMA and $MRNA

 

 

 

The post BIOTECH: A SHELTER FROM THE STORM? appeared first on Sick Economics.

3 TIPS FOR SURVIVING THE STOCK MARKET CRASH

“What goes up, must come down,” is a time-tested phrase that was proven correct with savage clarity during this week’s stock market mayhem. Financial panics are as old as money itself. Whether this is your very first crash as a stock market investor, or you are an old pro who has seen it all, here are three tips to minimize the damage to your portfolio and make sure that you survive the Great Coronavirus panic of 2020.


1. The Crash Isn’t When Fortunes Are Lost. The Crash Is When Fortunes Are MADE.

This may seem like a counterintuitive statement when everyone is panicking around you. But staying calm and deliberate when everyone else is panicking is how real money is made in the stock market.

Think about it like this. As a shareholder in a publicly traded firm, you are an owner in a business. There are two reasons why the value of your stake could go up, or go down. The first reason would be if something fundamental has changed about your business and the market it operates in. For example, a business that sold horse buggies would have become a poor investment as cars became the norm in early 20th century America. Kmart used to be a great business when department stores were the main way that people satisfied everyday casual needs. But with the rise of Amazon and the convenience of online shopping, the fundamental market in which Kmart operated changed, resulting in a massive loss in value for Kmart. If a fundamental aspect of a business changes, it may be wise to sell.

But the biggest financial opportunity you will ever encounter is when everyone else is tying themselves in knots over a condition that only temporarily affects the business that you own. The biotech and pharmaceutical world is a fabulous example of this phenomenon. This week we experienced one of the most severe stock market crashes in recent history. Everything went down, because, well, everything went down. But even if our current Coronavirus scare morphs into a drawn out recession, does that mean that 7 billion people on planet Earth will no longer need cures or medical advances? Even if the American or Global economy is temporarily hobbled, does that mean that pharma icons like Pfizer ($PFE), Merck ($MRK), and Eli Lilly ($LLY) are likely to fade into irrelevance the way Kmart did?

Very unlikely. If anything, the current international health freakout proves conclusively that people continue to value their health over all else. Healthcare remains a good place to invest your money for the long term.

Ok, so solid healthcare concerns will continue to serve a vital societal need, and demand will eventually recover. But why would now be a good time to invest? Why not just hide out and wait for the world to regain its footing?

Because now is when foolish or desperate people are selling cheap. To understand the magnitude of this opportunity, let’s look at some math.

Let’s say you invested $10,000 in Merck Pharmaceutical ($MRK) on January 3rd, 2011. As of February of this year, that investment would have returned 13% annually and your investment would be worth an impressive $31,141. After the trauma of 2008 and 2009, you would have waited until recovery seemed to be in the air, and earned a nice return.

But let’s say you bought in the midst of the chaos of the last financial crises. While stock brokers and investment gurus were busy jumping out of windows, you invested your $10,000 in Merck during July 2009. By February of this year, you would have earned an astounding 15.4% annual return, and your total shareholding would be worth a whopping $46,397. Decisive action during a crisis can lead to a courageous reward!

This isn’t some kind of new idea that I cooked up. The idea of running towards a burning financial fire, instead of away from it, is as old as money itself. As the Roman historian Pliny the Younger was quoted during the eruption of Mt. Vesuvius, audaces fortuna iuvat, “Fortune favors the bold.” How will your history be written during this crisis?

2. Cash Is King

There will be many deaths and near death experiences in this crises. Financial deaths of under capitalized biotech companies. I have written at length about the pros and cons of unprofitable companies. During moments of financial shock, the cons of unprofitability are about to become crystal clear.

In the jungle of Wall Street, the strong prey upon the weak. Expect a lot of this over the coming months. There are a lot of smaller, newer biotechs out there that have been making scientific progress on promising molecules. But they were funded in such a way as to require constant infusions of fresh cash. And why not?  It seemed like anybody with a PhD could access millions as recently as a few months ago.

That was then, this is now. In just a few short weeks, those torrents of random investor cash are about to become a trickle in a barren desert of financial austerity. Many promising biotechs will arrive at death’s doorstep, not for lack of promising science, but for a sudden cash crunch that will transform the industry.

But promising biotechs rarely die outright; rather they are acquired for a song by stronger competitors, competitors with cash reserves deep enough to make it through the crises. As you scan a forlorn financial landscape cluttered with the corpses of dead and dying unicorn stocks, seek out larger, more established innovation companies that were built to survive a crisis. They will feed on their weaker biotech brethren, and emerge from the crises even stronger.

Take Regeneron ($REGN)  pharmaceuticals, for example. Not only is Regeron cash flow positive, due to products that sell in almost any economic state, but management has wisely built up a $3 billion war chest. Another example would be Gilead ($GILD). As of year end 2019, they had a staggering $24 billion dollars laying around in bank accounts, in addition to life sustaining products that sell in almost any environment. Gilead was already primed to make several acquisitions in order to boost future growth. Imagine how much farther that investment capital will go now that most biotech stocks are selling at 20-50% off their former value!

The best advice for most investors right now is to simply do nothing. But if you must sell something, if you feel compelled to participate in the frantic melee that has become Wall Street, cull the weakest from your herd. How would you identify these? First, focus on companies that are either unprofitable, or even pre-revenue. Second, go to the company’s cash flow sheet. Look at the bottom line. How much do they burn every year? Every quarter?  Then compare that to the cash holding revealed on the balance sheet. How long can they burn cash before they need additional investment to keep the lights on?  A good candidate to sell would be any company that would run out of cash in the next 18 months. Money is about to become a whole lot harder to come by.

 

3. Everybody Pays For Their Education, One Way Or Another

Hysteria can manifest itself in a variety of different ways during the fog of war.  Perhaps one of the most virulent strains of hysteria that can strike is self blame. A lot of people see diminished portfolios, and will insist they did something wrong to themselves, and are at fault for “lost” money.

Of course this line of thinking may be invalid for a host of reasons. Money “lost” during a financial crisis may not be lost at all, but rather temporarily missing, waiting for an eventual resurrection in share price. Mistakes in the timing of certain investments, or the price paid for certain investments, may just have been hard to avoid given the particular circumstances at a particular time. But the most important thing to remember is that mistakes are learning opportunities. If you choose to make your mistakes into positive lessons, rather constantly reliving financial tragedies in your mind, you will have earned an MBA in the school of life.

Believe me when I tell you that I’ve lost a lot of money over the years in the stock market. I have both “temporarily misplaced” money during certain shock events, and I have even vaporized a good deal through just plain inexperience and, even, occasional stupidity.

But those weren’t losses. Those were investments. If you paid $200,000 to get a Harvard MBA (which people do), would you consider that money “lost” or “invested?”

Same thing with defeats, temporary or otherwise, in the stock market. You can run away, bury your head in the sand, and swear off stocks forever. Or you can treat the incident as a lesson from the School of Hard Knocks, and come back tougher. (And, eventually richer. Much richer. I can promise you that).  You choose your attitude when faced by setbacks. The choice you make will determine your long term financial status.

 

BONUS TIP!

You were only promised three tips at the top of this post, but if you have made it this far, you may already have a budding relationship with www.sickeconomics.com

Many have noticed that our newsletter stopped, and our publication rate slowed. Does this mean that we are out of the game?  Have we taken a beating in the markets and sworn of the dark arts of Wall Street?

No chance!!! We are coming back stronger than ever. Operations have slowed due to recent renovations on our site. Look for the publication of our upcoming ebook, “Your First Biotech Million.”   As American Revolutionary Patriot John Paul Jones once declared in troubled times:

“WE HAVE ONLY JUST BEGUN TO FIGHT.”

 

 

The post 3 TIPS FOR SURVIVING THE STOCK MARKET CRASH appeared first on Sick Economics.

3 QUESTIONS THAT EVERY BIOTECH INVESTOR SHOULD BE ASKING

“If you don’t ask the right question, you don’t get the right answer.” That was one of my great grandfather’s favorite sayings. He died thirty years before the biotech industry was even born, but his saying is as relevant today as it was a half century ago. Here are three questions that every biotech investor should ask while evaluating a potential stock purchase.


1. What is the company’s TAM?

TAM stands for Total Addressable Market. TAM is a common metric in the biotech industry, and it helps executives and investors understand the size of a business opportunity. For example, if you are considering investing in a company that is searching for a cure for Parkinson’s disease, you would be looking at a very large TAM. According to the Parkinson’s Foundation, about ten million people worldwide suffer from that disease, and very few effective treatments currently exist. So the commercial potential for an effective drug could be well into the billions in annual sales. That is a very large TAM. On the other end of the spectrum, you might consider investing in a company that has a drug candidate for Acid Sphingomyelinase Deficiency, a rare genetic disease that affects about 1 in 250,000 people. This would be a much smaller TAM.

A small TAM does not always mean a small financial opportunity but it does drastically affect the strategy of the biotech, and different TAM sizes tend to present different risk profiles to investors.

Let’s go back to the example above. At its core, the discovery and commercialization of a drug represents the resolution of a scientific riddle. Whether a disease affects ten million people, or just one in ten million, the malady is still a scientific mystery that must be solved. Solving that mystery can be a torturous journey of many years and many hundreds of millions of dollars. The problem is, it may cost just as much to cure Acid Sphingomyelinase Deficiency as it does to cure Parkinson’s. So we wind up with very different commercial propositions.

Parkinson’s is a notorious scourge; most of us can easily recognize the symptoms. This means that, if an effective treatment is discovered, the fixed costs can be shared by millions of people. It also means that the pharma company has a strong argument for charging high monthly fees to insurance companies, individuals and Uncle Sam. Let’s say the drug cost $1 billion to develop over many years. The biotech can charge $12,000 annually per person, and if one million patients go on the new medicine, they are looking at $12 billion in annual revenue. A handsome return indeed, and potentially an acceptable price to Society for a cure to this dread disease. That’s the magic of a large TAM.

Now let’s consider those lonely patients who suffer from ASD. Their drug also cost $1 billion and years to develop. But there may well be no more than 1,000 patients across the United States who would need the drug. At this rate, the biotech company would need to charge $100,000 per patient, per year, just to recoup the investment over ten years. Bad Math.

Does this mean that a wise investor should stay away from companies that seek to treat rare diseases? Not necessarily. In fact, there has been a wave of biotechs specifically built to address the needs of victims of rare diseases. The thinking has been that the bizarre economics in these niches would scare away competitors.

There may be nothing worse than diabetes in America. Our struggles with this widespread disease are well documented. However, such high publicity and large TAM have attracted dozens of competitors, large and small, who have launched many different kinds of medicines into the diabetes market. As a result, both patients and insurers can be choosey consumers. Diabetic patients have a lot of treatment options, which would make this market dicey for new entrants.

However, people unlucky enough to suffer from rare diseases have few options, if any. This means that insurers and patients may be willing to pay very high prices for medicines that only demonstrate marginal efficacy. The drama surrounding Duchenne Muscular Dystrophy (DMD) and Sarepta Therapeutics ($SRPT) is a perfect example of this phenomena.

There are a lot of ways to make money in biotech investing. Both companies targeting large TAM opportunities and small TAM opportunities can potentially mint money. But they are different beasts, who attract different kinds of investors. Investigate a biotech company’s TAM before anything else, and you will be much better positioned to make some wise decisions for yourself.

2. What is the Company’s Funding Situation?

Many of today’s publicly traded biotechs lose money. There may still be very good reasons to invest in a company with negative cash flow, but understanding the company’s current financial position is critical to understanding the risks that you would be taking as an investor. Let’s look at a few examples.

You have $1000 to invest, and you are choosing between two companies that seem promising to you. Company A went public two years ago, garnered a lot of publicity and big name investors, and raised $700million in their IPO. They are dealing with cutting edge science, and they are still very early in the discovery process. They are about to begin three phase I studies, and they have many other preclinical studies going on. This means that they could be years away from obtaining any meaningful revenue, let alone profit.

After looking at the cash flow statement on their quarterly report, you can estimate their “burn rate,” or amount of capital that they use per year. Two years ago, after the IPO, they started with $700 Million in the bank, and now they have $500Million left. So, they are burning through about $100 million per year. If they maintain their current burn rate, they could go 5 years before having to worry about keeping the lights on.

Company B was founded by a few professors from MIT, and didn’t garner as much publicity. They raised just $60 million at their IPO two years ago. When you check their balance sheet, you can see that they have just $20 million left in the bank. When you check the cash flow statement, it looks like they have been burning through about $20 million per year. Since their IPO, they have had some success with phase I trials, and they currently have an ongoing phase II trial. It looks like they have some exciting science in their possession, but some kind of financial event is going to have to happen within a year, or they will “run out of gas” and go bankrupt.

Which company is a better place to invest your $1,000? The answer is, “it depends.” It depends on what kind of investment you are looking for, and how much risk you are willing to take.

On the surface, company A is less risky. They are so well funded that they can just keep scraping away at scientific discovery, with little regard to revenue, for years. If they don’t start to bring in revenue within the next few years, they will still be in a strong negotiating position to raise more capital. They can chug along for a long time, with nothing really happening.

Some might view that as a “pro,” but more aggressive investors might view that stability as a “con.” The well fed executive team leading company A could easily become complacent. Focusing on science is great, but many more aggressive investors might prefer a company’s management to seek profitable opportunities, sooner. With five years worth of cash in the bank, there may be a certain sense of urgency that is missing.

Company B needs to make something happen, and soon. That makes it a risky investment. They might issue new stock shares on the open market, which could dilute existing shareholders. They might sell a big block of shares to a new investor, which, if done at unfavorable terms, does not help existing shareholders. Someone might loan them money at a very high interest rate. Or they might sell the company outright. If they are just months away from running out of cash, you can imagine, company B is not in a great position to negotiate.

However, some thrill seeking investors prefer just these kinds of situations. Depending on where exactly the science is, company B may still obtain new capital at favorable terms. Analysts and nay sayers may have realized that the Company B is low on cash, and pushed share prices down far below their intrinsic value,meaning shares can now be purchased at bargain prices by investors who don’t mind going on a roller coaster ride.

In short, there is no simple, “right” answer. Company A might be better for a long term, “steady as she goes,” investor, while Company B might be better for a thrill junkie. But if you haven’t done your homework, then you are just blindly gambling on whatever stock looks sexy today. Asking the right questions around a biotech’s finances will help you gain a more solid understanding of the stock. You’ll sleep better at night knowing what you are buying.

 

3. What is My Own Tolerance for Risk?

The two questions above should help you determine what class of company you may be investing in, and how risky that investment could be. The last question may be the most important: how much risk can you handle?

Here is an interesting fact: most American investors under-perform the Market on a regular basis. In fact, investors typically earn between 2 and 4% less than the benchmark index. In the world of investing, that 2% gap, year after year, can easily add up to millions of dollars lost. One reason why investors do so poorly, even when the Market does well, is that they don’t know themselves, and they buy the wrong investments for them. If they buy something that is too risky for them, they panic, and they sell at the wrong time. If they buy something that is not risky enough, they get bored, and they sell at the wrong time. Assembling the right equity portfolio for yourself is like going to the grocery store and picking just the right items off the shelf. Most grocery stores these days are filled with all kinds of delicious treats. But what if you buy strawberries when you should have bought bananas? What if you bought Special K, when you should have bought Frosted Flakes? All of these options are good, but are they all good for you?

One time honored method of smart shoppers is to make a list before you enter the store. This method causes a shopper to think about what she needs before she enters the store, which results in less buyer’s remorse later. You can do the same for stocks. Let’s say you already have a portfolio of steady value stocks that grind out dividends quarter after quarter. You could use some excitement in your life. So you dedicate 10% of your capital to those riskier biotech stocks. Or you already have a bunch of risky biotech stocks, and the constant gyrations in share price have given you too much indigestion. Start dedicating capital to some larger, more mature biotech stocks such as Amgen, Gilead, or Biogen. Asking yourself how much risk you can stomach before you go shopping gives you a better chance of building a winning portfolio for yourself.

A lot of people never move forward in stock market investing simply because they don’t know where to begin. The three questions above are a great place to start. Once you get used to asking these same three questions, again and again, you will be surprised at how good you get at ferreting out the answers. Good questions will bring good answers; good profits are rarely far behind.

 

 

DISCLOSURE: The Sick Economist owns shares in $GILD

 

 

The post 3 QUESTIONS THAT EVERY BIOTECH INVESTOR SHOULD BE ASKING appeared first on Sick Economics.

MINIMIZE YOUR TAXES WITH BIOTECH INVESTMENTS

“Death and Taxes are the Only Sure Things in Life” – Benjamin Franklin

Did you ever notice that, when they talk about business magnates in the Media, they typically refer to the magnate by his total wealth, rather than how much money he brings home each year? The typical headline these days might start with the phrase, “billionaire Elon Musk is preparing to launch a new Tesla model….” People love to throw around the phrase “billionaire” …but they never mention exactly how much money Elon Musk or other luminaries of the business world take home every month.

That is because most very wealthy people actually seek to minimize their income, while at the same time maximizing their net worth. Why would this be? If you owned a large, thriving and lucrative business, wouldn’t you want that business to write you a fat, juicy check each month?

Not necessarily. Because fat, juicy checks typically also bring a tax bill which can spoil anybody’s appetite. In America today, most taxation revolves around income, not assets. Therefore, one way to lower your tax bill is to lower your income.

But don’t these business big shots need huge income to pay for their gold-plated lifestyles? Believe it or not, the answer is typically, “no.” Elon Musk is said to own at least four different mansions in the Los Angeles area totaling $100M in value. That sure does seem like a lot of money. But it actually pales in comparison to his multibillion-dollar net worth. Believe it or not, Elon Musk is actually living well within his means. If his businesses paid out extra income to him, all it would mean would be a gargantuan tax bill and a scramble to figure out where to put all the cash.

Of course, I am not a Titan of Industry, and you probably aren’t either. However, if we aspire to be rich, we might as well learn from people who have already achieved that goal. Simply put, to become wealthy, you should be accumulating more assets than what you need to fund your daily lifestyle. Other than the minimum cash you need to pay your bills, defer the income, or get ready to feed Uncle Sam’s insatiable hunger.

One great way to build wealth without income is to invest in young biotech companies. These companies seek to generate wealth for shareholders through stock price appreciation, not income. Along the way they build tangible assets that have a measurable value. However, many are so young, they don’t yet generate a profit. Some are so young that they actually have no revenue at all.

 

Biotech Investor as Real Estate Developer

What??? Why would a company with no profit, and not even revenue, be trading publicly to begin with? Why on earth would you want to invest in a company that hasn’t even brought in a single dollar yet?

Before we go any further, let’s be clear: investing in any pre-revenue company is risky business. If you choose to bet on this kind of company, you are hoping to buy into world changing innovation early, while the price is still low, before the rest of the world discovers what is going on in the company’s laboratories. You are taking a calculated risk, because any perceived value is theoretical, and based on things that you think will happen.

In this kind of scenario, biotech companies are much more like real estate development companies. Except, instead of developing communities or shopping malls, they are developing molecules. A real estate development company seeks to create physical projects that will eventually generate tangible, real revenue. But it may have to invest for years before any one project becomes obviously viable. It’s the same scenario for a young biotech.

Try this mental exercise. You walk through a gentrifying part of town, and you notice a ramshackle building on a choice corner lot. The location is obviously great, but right now it’s not worth much because the lot is occupied by a slum. The next month, you walk by the same lot, and you notice the slum has been razed, and there is a shiny new sign saying “coming soon, luxury rentals.”

At that moment, the developer has already sunk huge amounts of money into purchasing the lot, razing the slum, and obtaining plans and permitting to move forward with a speculative new development. They haven’t put one piece of rebar in the ground yet…revenue is far away. But does that mean the project has no financial value? Or, in fact, does it have a larger value than it did when it was just a slum, because substantial progress has already been made? This is just the same as a young biotech with novel agents in early clinical testing.

Now let’s say, six months later, you walk by the same lot, and you notice that construction has begun, and a towering rental building is half built. Still, little tangible

cash flow for the developer, and certainly no profit. Does that mean no real financial value? Is the lot worth more than it was six months ago, when it was a barren slum, or more, now that it’s halfway to being a brand-new venture? This would be the equivalent of a pre-revenue biotech with agents that have passed through some important trials, but are not yet ready for launch.

Finally, a year after you first laid eyes on the property, you see a tower has been mostly completed. At least the outside is all done, and the developer is planting trees and grass around the property…a new sign is up proudly pronouncing, “coming soon.”

All this progress, but still no revenue, and certainly no profit! But would the value of the project be more than it was when it was only half built? This would be a biotech with

agent, or agents, that have just passed stage three testing, and about to file for FDA approval. Although the young company still hasn’t made a dime in tangible profit, they obviously now possess assets that they have greatly increased in value.

The reason why these kinds of companies would want to be public would be to provide some liquidity to management and scientific teams that can toil for years to build up the company’s scientific assets. Let’s say you are a chief medical officer, and you joined the young biotech when it’s novel agent was still being tested in rats. Now you have an agent that has made it all the way through phase two testing. This means that your work has consistently increased the value of the company’s assets for quite some time, even if this work has not yet resulted in revenue for the company. In fact, from “preclinical” to phase two could take years. But you have bills that need to be paid today. By earning shares in a young, pre-revenue company, you can keep paying your bills until your big breakthrough finally comes. Simply put, young companies that allow shares to trade publicly may well increase the patience and financial endurance of their high value executive teams. Revenue or not, value is being created as a drug marches along the development process, and share based compensation helps a young company make that value tangible for employees and early investors.

No Income, No Tax

All of this value is created, without generating income. This means you have deferred taxes. To return to the example above, let’s say that you buy shares in a young biotech right as it launches its first Phase One clinical trial. You buy at $5.

Five years later, the biotech has put the same molecule though many other trials, and produced great results, attracting the attention of the Media and financial analysts. Now the stock trades at $20.

But it’s still a small company, and it might not have the resources to bring a drug to market all by itself, so it sells itself to a larger Big Pharma company. They pay the shareholders half in stock, and half in cash. So now you finally have to pay long term capital gains taxes on your greatly appreciated shares, but ONLY on the cash portion of the payment. The stock payment is tax free. So now, you have successfully deferred the taxes on half of your investment yet again. Now you own Big Pharma shares, and the whole process of share price appreciation begins again. It could be years before you finally sell your remaining shares and have to pay taxes.

This is what Elon Musk does. At a recent civil trial, he testified that most of his net worth is actually tied up in two unprofitable companies (Tesla and SpaceX). One of the reasons why these companies have not produced an annual profit is because they are constantly pushing boundaries, and investing in innovation (much like biotech). Both companies produce tangible, measurable growth assets in the form of patents and proprietary new technology (much like biotech). This strategy minimizes Musk’s tax bill, and maximizes the growth potential of his wealth. You can do the same.

 

The essay was originally posted on infoforinvestors.com

 

 

The post MINIMIZE YOUR TAXES WITH BIOTECH INVESTMENTS appeared first on Sick Economics.

THE PROS AND CONS OF SHORT SELLING

Guest Post By: Baruch Silvermann of The Smart Investor.

Do you know about short selling?

It actually means that you’re selling something that you’re not even in possession of. When it comes to stocks this means selling a stock at a high price when you think that it’s going to end up dropping later. Then you can buy it again at the lower price.

With this type of investing you’re actually setting yourself up for a whole lot of risk because you’re trying to beat the market. If you purchase a stock you’re only out potentially the price of the stock or how much it decreases. For those who use short sale, however, you could be out a lot more.

 

Short Selling – How it All Works

Now, with this type of investing you’re going to be selling something that you haven’t actually purchased yet. So, what you’re trying to do is make a profit and that involves selling something for more than you think it’s going to be worth in the future so that you can potentially buy it back at that lower rate.

In order to buy things without having money, however, you’re going to borrow the stock or the money from whoever does own it and then you’re going to sell it to someone else. You would then have the pay the person the amount for the stock and you would need to pay some type of interest as well for the fact that you borrowed their stock without paying for it right away.

Keep in mind that you’re going to have to pay the amount of money that the stock is worth when you actually buy it and that could be more than what the stock sold for. That means you could end up losing money on the transaction and that’s where you’re going to have the higher risk.

If you sell short sell stocks you could lose a whole lot of money and far more than just the cost of the stock itself.

 

Why You Should Consider It?

So, why would you want to get involved in short sales if it’s that risky? There are a few different reasons.

Hedge Your Bets – Some people like to hedge their bets on other stocks through a short sale. So, if you are worried about losing your money you can open up a short position for your stocks. This helps you to keep the stock price that is already there at the time. You then don’t have to worry as much about dropping prices because you get an increase if that happens. If the stock rises you’re going to lose a bit, but you’re still going to have other benefits.

Speculating – If you think that a stock is currently priced at more than it’s worth or you think that there will be something happening within the company that’s going to decrease the value of the stock then you can use a short position to help you increase your overall earnings. But in order to do this you need to be able to take a big risk and you need to do a whole lot of research. In general you’re going to be going against the norm, but if you’re right you could get a windfall.

Better Tax Benefits – When it comes to working with short sales you’re also going to get better tax write-offs. If you want to sell your stock but you know that you could write off more if you wait you could actually hedge with a completely different stock. This will give you a period of time where you can wait and hopefully improve the amount of money that you’re going to make in the long run.

Where You Run the Risk?

Short selling is a very risky strategy, especially for beginners. Before getting a decision, you should fully aware of the different risks of short selling.

Unlimited Loss Potential – What happens if you short a stock and then the price skyrockets? Well, you’re going to be out all of that potential money. You’re going to be missing out on the benefits because you decided to short it. If you short at $10 then you’re only going to make up to that $10. So you’re going to be protected from too much loss on that side of things, but if the stock goes up in price you’ve lost that potential.

Interest Rate Changes – You could end up with a completely different interest rate because of the availability of shares within the market. You may even have a quoted rate that changes as you work through the trade, and that could cause you to lose some of your profits or to lose even more when it comes to the losses that you incur.

You May Not Make It – Not every trade is going to be successful. In fact, if the shares aren’t available at the time that the trade actually goes through and the sale is made you could be on the hook for making the purchase. That purchase could be more expensive than what you had originally figured on and that is going to cut into your profits in a major way. Depending on how much the stock price went up you could really be in trouble with this type of failing.

 

 

Bottom Line

Overall you’re going to have some benefits when it comes to short sale. You could find yourself making a great deal and you could actually make some great profits. You just need to be willing to take a pretty major risk in order to do it. That’s because there’s a whole lot that can go wrong when it comes to a short sale.

If you short a stock and the price falls you could still profit and you could actually profit a lot. On the other hand if the stock increases in price you’re going to be out a whole lot of money, depending on just how much the stock goes up you could lose out on all of your profits and then some.

The most important thing that you can do is make sure that you’re aware of the market and that you’re paying close attention to everything that’s happening around you. Evaluate the potential of a stock and always have a target in mind for your profits. You want to make sure that you’re closing out trades when you get to that target or when you’re able to get close. If you try to make too much with each trade or you get too greedy you could find yourself struggling just to make ends meet with this method.

Be prepared for the fact that you could win big and you could lose even bigger. This type of trading is a very complicated game and you definitely don’t want to find yourself falling too far behind.

 

 

 

About The Author:

Baruch Silvermann is a personal finance expert, investor for more than 15 years, digital marketer and founder of The Smart Investor. But above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.

 

 

The post THE PROS AND CONS OF SHORT SELLING appeared first on Sick Economics.