28 Apr Investing in a Cure for COVID-19
If you haven’t heard of remdesivir, an antiviral drug, you will soon.
Remdesivir is one of the most promising treatments for COVID-19 that is undergoing trial testing.
In fact, shares of the drug’s maker, Gilead Sciences (NASDAQ: GILD), surged close to 10% on 17th April when initial results suggested that COVID-19 patients were responding well to the treatment.
I happen to own shares of Gilead before remdisivir was revealed.
But if you think it was a genius move on my part … well, it wasn’t.
My investment in Gilead was made in 2015, some five years ago.
Back then, the company was riding high on the back of its successful Hepatitis C drug, Sovaldi.
But the threat of looming competition had sent its shares down.
With the price to earnings ratio battered to the low teens, I decided that it was a risk worth taking and bought some shares.
By then, Gilead already had a strong HIV drug portfolio.
Sovaldi promised to be the foundation for a new Hepatitis C drug portfolio for Gilead to expand beyond its roots. The situation was not as bleak as the share price decline would suggest, I reasoned.
But alas, history would show that I had misjudged the ferocity of its competitors.
Attracted by Sovaldi’s margins, competitors slowly chipped away at Gilead’s market share.
Between 2015 and 2019, sales fell by almost a third while free cash flow was more than halved. Shares cratered as a result of Gilead’s weak business performance.
Despite my misjudgement, I did get some things right.
When I made my investment, Gilead was already a strong financial performer.
In 2015, the company generated US$19.5 billion in free cash flow and had a fortress-like balance sheet loaded with close to US$15 billion in cash.
Even after the decline in revenue, Gilead still generated over US$8 billion in free cash flow for 2019.
In sum, Gilead had always been on a solid financial footing.
The strong free cash flow supported a dividend that increased by almost 100% between 2015 and 2019 even as revenue fell. At a payout ratio of less than 60%, Gilead’s dividend payment was well within its means.
Overall, it would seem that I got some things wrong, and other things right.
But was my initial investment decision correct?
COVID-19 and the role of luck
If I am feeling generous, I could say that Gilead’s innovative culture and financial means led to the creation of remdesivir.
That is, if I am feeling overly generous.
But if I am being honest, luck played a bigger role in this case.
To be sure, no one’s investment process is perfect.
Even when we have a time-tested, robust investment process, things may not turn out the way we think it will.
Michael Mauboussin, head of research at Counterpoint Global, has a particularly good way of framing the connection between a good investment process and the investment outcome, as shown in the table below.
|Good outcome||Bad outcome|
|Good process||Deserved Success||Bad Break|
|Bad process||Dumb Luck||Poetic Justice|
In Mauboussin’s parlance, it is possible to have a good investment process and yet suffer from a bad break and lose money. At the same time, we shouldn’t be too happy if there was a good investment outcome based on a flawed investment process.
So, going back to my Gilead investment …
With the benefit of hindsight, I can conclude that my understanding of the company’s competitors was flawed.
My investment thesis did not play out.
The positive result for remdesivir, which led to the surge in Gilead’s share price, was merely a lucky break for me.
Win or learn
“I never lose, I either win or I learn” — Nelson Mandela
We will not always be right when we invest.
But when we make a mistake, it is important that we recognise our error and try to avoid making the same mistake again.
That, in essence, is how we can become better investors.
We have to make an honest assessment of our own investment results, as I have done above.
To be able to do so, we should make it a habit to document all our investment decisions.
We should know …
Why did we choose to buy the stock?
What were the business traits that we liked?
Were we able to recognise the risks ahead of time?
To take it a step further, we should schedule a review of our investment decisions regardless of whether there is a good or bad outcome.
Only then will we be able to recognise where we have gone wrong.
If the investment has done well, we have to examine the factors to see what extent our investment thesis played a part.
We can learn from both our successes and our failures.
More importantly, we can apply our learnings ahead.
To use Mauboussin’s framework, we can work to incorporate our lessons to refine our investment process.
Get Smart: Expanding circles
Gilead represented my first foray into the bio-medical space.
Being aware of that, I have kept my position within my US stock portfolio small.
Today, despite the enthusiasm for remdesivir, my position in Gilead is still slightly in the red.
I am not losing sleep over the stock, precisely because I have not invested a single cent above what I was comfortable in holding.
Taking small positions allows me to test new ideas.
By putting some money on the line, I stand to gain if the stock does well.
But if the stock doesn’t do well, then a small position is all I would want.
More importantly, taking small positions allows me to expand my circle of competence and to test new ideas.
The lessons I learn are then incorporated into my investment process.
Over time, I am able to tilt the odds to my favour.
While I am not always right, the big winners in my stock portfolio, which includes the likes of Netflix (NASDAQ: NFLX) and Amazon (NASDAQ: AMZN) held for over a decade, have far outpaced all my losing stocks.
So, go ahead.
Test new ideas. Keep it small. Learn.
Then, apply your lessons forward.
If you can do that consistently, I submit that you will increase your chances of becoming a great investor.
Onward, Smart Investor.
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Disclaimer: Chin Hui Leong owns shares in Gilead Sciences, Netflix and Amazon.