Watchlist Building in Pharma: Pre-Investment Thesis

The business world of pharmaceuticals is massive. There are over 3,000 end-to-end pharma companies, highlighted below. These are known as FIPCOs, or Fully-Integrated Pharmaceutical Companies. If a company is building and conceptualizing treatment ideas, leading drug discovery processes and fully commercializing their products to recapture R&D value, then they’re a FIPCO. Statista projects that pharmaceutical industry revenue will reach 1.156T by the end of 2024. The anticipated CAGR, or compound annual growth rate, is 6.19% through 2028. Though sector growth may vary, there are profits to be made in identifying the biotech companies that are capitalizing on growth trends. Company size, area of research, portfolio depth…there are plenty of ways to slice your analysis. I’ll outline a simple approach below, but I believe this should be adapted based on preference. Let’s answer the question of “Where to start with picking?”

Credit: Biotechgate

My interest lies in Pharma. Independent of industry, we’ll need to pare down to a reasonable number of stocks to follow. If you have too many priorities, then you have none. Equity research analysts often have a coverage universe comprised of somewhere between 5 and 30 stocks. These are stock groupings that share similar features and can be assessed or evaluated through a similar lens. If the sector or sub-sector is zero-sum, then the gain of one company may be the loss of another. Market intel can be leveraged to understand correlations within the coverage universe.

One of the parameters I’ll use to pare down my watchlist is market capitalization. Below is a chart with descriptions and dollar cutoffs for market capitalization groupings. Market cap = number of shares outstanding * stock price.

Credit: Me

The raw watchlist is where we’ll start, but we have some additional paring to do:

VTRS,TEVA,TAK,PFE,RPRX,GMAB,GSK,BAX,SNY,BMY,CTLT,INCY,LEGN,AZN,GILD,RDY,TECH,BMRN,BNTX,NVS,MRNA,MRK,SRPT,NVO,NBIX,ALNY,JNJ,BGNE,ABBV,ZTS,LH,BIIB,UTHR,AMGN,KRTX,ICLR,WST,ARGX,MEDP,VRTX,LLY,REGN

These are the stock tickers of 42 large-cap and mega-cap biotech/pharmaceutical companies with established revenues. Their portfolios run the gamut from lipid-lowering and anti-inflammatory agents to oncology and sensory organ treatments. Gene therapies, and their 7-figure price tags, are finding their way into several portfolios now too.

My criteria for picking these companies were rather straightforward. The pre-requisite for inclusion is:

A)     Market capitalization of > $10B

B)     Able to be traded on US markets

I utilized A because there is uncertainty in early-stage biotech companies. Companies in early phase studies and with single-product portfolios are at higher relative risk. Companies within the initial list are more likely to have liquid markets up and down the options pricing chain. In these cases, the risk, at the time of trade, is better-defined than a lower cap stock. Item B is crucial because the US markets are primarily where trades will be placed.

Let’s add to the criteria to trim down:

C)     Human drugs and book of business primarily pharmacy

Cuts: ZTS, BAX, MEDP, WST, LH, RPRX

Zoetis sells products targeted for animals and livestock. Baxter and West Pharmaceuticals do more healthcare products and packaging. Medpace and LabCorp are more service-oriented. Royalty Pharma is a brand product royalty aggregator. The initial list was a general “pharmaceutical company” search, so this helps narrow our focus to companies with end-to-end drug discovery and drug distribution that is focused on human care.

Next criterion item:

D)     Dividend-paying stocks

Cuts: VRTX, REGN, MRNA, BIIB, ICLR, ARGX, BNTX, GMAB, ALNY, BGNE, BMRN, TEVA, NBIX, INCY, KRTX, LEGN, SRPT, UTHR, CTLT

My mindset with options writing: “get paid while you build a portfolio of stocks that fit your needs.” As your wealth grows, dividend-paying stocks will offer some additional income to assist with rebuilding free cash flow as you continually re-deploy available money into cash-secured puts. If you have an interest in immediately selling back any shares that get assigned to recoup capital, then the “dividend-paying” metric is not a differentiator. As aforementioned, tailor your watchlist to your preferences. There are additional ways to stratify within the dividend-paying grouping, such as dividend yield, payout ratio, 1yr, 3yr or 5yr dividend growth rate or even dividend history. There are some great resources to learn more about dividends. Here’s a post from Bob Ciura @ Sure Dividend.

Final list count: 16

Names: LLY, NVO, JNJ, ABBV, MRK, AZN, NVS, PFE, AMGN, SNY, BMY, GILD, GSK, VTRS, RDY, TECH

The final list, for now, is displayed in the chart below by descending forward dividend yield. I could “tech”-nically cut Biotechne-corp, but with the rise of biologics and cell/gene therapies, I left it in to evaluate in the future.

Credit: Me

In summary, we’ve pared down a watchlist to less than 20 stocks that meet 4 elements of pre-specified criteria to fit the long-term needs of a growing portfolio. Or growing basket of one slice in your portfolio. Build out an investment thesis perspective based on your narrowed niche. You can do some further stratification as well, by nominal share price groupings, revenue growth rates, credit ratings, IRR and annualized growth rates based on real options trading data. Thanks for your attention and keep learning!