Long-term Investing in Biotechnology

Investing in biotechnology attracts investors due to its potential of higher than average returns. A company that is expected to successfully complete the Food and Drug Administration's drug approval process can significantly outperform the market. However, it should be noted that the value of these stocks can be cut in half just as quickly.

Where there is reward, there is risk. However, time is one of the best risk mitigation strategies when it comes to investing. So consider the following when thinking about long-term investments in biotech.

Why Invest in the Biotechnology Sector

The healthcare industry has been going though a lot of change lately due to the varying political landscape. Despite all of this uncertainty, it should be obvious that the healthcare industry is not going away anytime soon. The demand for health care is supported not only by our instinctual drive for survival, but also economically though government programs (i.e. your tax dollars).

When investing in this space, the difference between biotech and pharmaceutical companies should be understood.  Pharmaceutical companies manufacture and distribute chemically engineered medications strictly for healthcare purposes, think synthetic chemical compounds. This is in contrast to biotech companies which develop medications and other solutions (i.e. pest resistant foods) on a biological basis.

Biotechnology companies spend more on research and development than pharmaceutical firms, thus are provided with patents with a longer protection period. Additionally, biotech companies develop solutions that reach beyond medications, thus they have a wider applicability across industries.

As stated above, the demand for healthcare will not fade anytime soon and there is little doubt that the government will continue to subsidize it. This makes a case for the prospects of this industry as a whole. Additionally, our society has begun to shift away from generally accepting chemical laden products. This can be seen through less use of certain plastics, foods and medications. Thus, biotechnology will continue to take an important role in shaping the world of tomorrow.

Seek Broad Diversification in Biotech Investments

It should be understood that biotechnology stocks can be some of the most volatile. Volatility, being a double-edged sword, provides exciting opportunity for traders but heartburn for the long-term investor. To reduce volatility, while still participating in the potential upside of this industry, it is recommended to remain well diversified.

One of the easiest ways to ensure your biotech position is diversified is to invest in a Exchange Traded Fund (ETF) such as iShares NASDAQ Biotechnology Index (IBB). This ETF is comprised of shares of 162 biotechnology companies. While this sector is speculative, IBB is comprised of roughly 63% large cap stocks. While the remaining 37% is comprised of mid, small and micro cap equities.

IBB's Top 10 Holdings

Match Portfolio Holdings with Future Expenses

Investing and portfolio management, being a significant element within the financial planning process, gets plenty of attention from academic circles. A few years ago I came across the theory that claimed "a proportion of a long-term retirement portfolio should match the expenses in which it is expected to resource in the future".

This theory seeks to match the inflation rate of an investor's future retirement expenses with the growth rate of the companies that operate in that sector. Simply stated, if you will expect to have out of pocket healthcare expenses during retirement, then a portion of your retirement portfolio should include healthcare stocks.

Organizing your portfolio in this manner is intended to ensure that the growth of your investments does not lag (or fall behind) the increasing cost of the products and services you will need in the future. Investing in biotech can satisfy the parameters of this financial planning theory as its reasonable to assume that the medications in research and development today will be prescribed to patients in the near and distant future.

Timing Your Biotech Investments

The biotechnology sector, as evidenced by ETF's such as IBB, experienced significant growth between 2012 and 2015. This growth was due to a variety of industry and political circumstances. However, these stocks were hit hard halfway through 2015 and have been inching up since a bottom was formed in early 2016. All being said, this large correction (~37%) was needed and should be considered "healthy".

As I write this, the sector is having one of its best week's in a few years. For long-term investors this may signal the start of a great opportunity. I usually like to invest in stocks (or ETFs) that have experienced a 20% or greater correction and show signs of upward momentum. Taking a look at that chart, it seems to fit my criteria pretty well.

 

 

The CAN SLIM Investing Strategy

The CAN SLIM investing strategy is a comprehensive stock selection system, and is one of my personal favorites. CAN SLIM is an acronym that represents each step William O`Neil developed to identify stocks that have the same characteristics as past market winners. Thus, this method utilizes a seven step process in the effort to find the best stocks in the market.

The CAN SLIM investment strategy is geared towards finding growth stocks. Growth stocks tend to outperform the market and are considered to be higher than average risk investments. However, where there is more risk, there is more reward. This is in contrast to other stock screening methods such as value and momentum investment strategy. The CAN SLIM stock screening methodology utilizes the following criteria.

"C" Current Earnings

The first step in the CAN SLIM screening process involves the analysis of a stock's current earnings. The investing strategy uses a floor of 25% quarterly earnings growth. This means that screen will filter out any companies with less than 25% quarterly earnings growth.

Why is earning growth important? Simply stated, the more a company earns, the more a company is worth. If the Company's earnings are increasing rapidly, their sales are probably increasing as well. This is an indication that a company is outperforming it's competition and who's stock will most likely outperform the market.

"A" Annual Earnings

The second step in the screening process seeks to ensure that the Company's earnings growth is not a short-term trend. When limiting your analysis to a Company's quarterly earnings, the trend can be deceiving. This is due to a variety of business decisions that can affect the appearance of earnings in the short-term (such as temporary cost reductions). To avoid being duped by a short-lived earnings pop, O'Neil included annual earnings growth as an important investment selection criteria.

So keep in mind when searching for stocks with the potential to outperform, annual earnings growth of at least 25% is important. Bottom line, this is a long-term earning growth screening criteria that seeks to eliminate companies that do not have sustainable earning growth greater than 25%.

"N" New Product or Service

The third criteria when evaluating investment opportunities with the CAN SLIM strategy seeks to find companies that have a high probability of succeeding in the future. It should be noted that the first two criteria (earnings growth) in the CAN SLIM investing system are easily obtained and measured, this third one is a little squishy (to use a technical term).

As an stock investor or trader, you should be forward looking. Meaning that the stocks you buy today should have something that makes it stand out in the future. This can be the brand new and innovative product, technology or service.

Some investors decided to use a stock hitting a "new high" as satisfying this criteria as its easier to measure and eliminates the need for a subjective assessment. At the minimum, avoid buying stock in a Company whom is clinging on to old technology, outdated products or business practices.

"S" Supply and Demand

Ultimately, the price of a stock is determined by supply and demand. If there is greater demand for a stock then there is supply, the stock's price increases. Inversely, if there is greater supply of a stock then there is demand, the share price falls. It's interesting how these basic principals of microeconomics (and human emotion) drive the markets.

With that said, stocks under accumulation are in demand (we want to own stocks that are in demand). This criteria is usually measured through analyzing stock trading volume. When assessing trading volume look for increasing trends and large spikes (greater than average) in buy volume. This indicates that the demand for the Company's stock is increasing.

"L" Leader or Laggard

The next (and fifth) step in the CAN SLIM investing system seeks to identify stocks that are market leaders. This investment strategy leverages a measure called Relative Strength (RS), which is used to determine if a stock outperforming or under-performing the market as a whole.

The CAN SLIM investing system utilizes a 1 - 99 point rating scale to rate a stock's relative performance over a 12 month period. As an example, if a stock is rated with a RS of 90, this indicates that it is outperforming 90% of the market.

Logic would lead you to believe that buying a stock with a rating in the high 90s would be the best choice. However, remember that once stocks have had a good run higher, they pull back and go through price consolidation for a period of time. Thus, it is a best practice to look for stocks in the RS range of 80-90.

"I" Institutional Sponsorship

In the stock market there are "heavy hitters" that are referred to as institutional investors. These large organizations (i.e. pension, mutual, hedge funds) have trillions of dollars in assets. When these institutions begin buying a particular stock, they have the ability to make the prices move for a long time. This is why the sixth criteria in the CAN SLIM investing strategy seeks to ensure that the stock has institutional sponsorship.

Institutional sponsorship can be measured in a few ways. The most popular being increasing or spiking volume (accumulation), however an investor can also sort through the institution's investment documents. When institutions begin to buy a stock, they do so overtime. When spacing out their purchases (think millions of shares), these institutions are trying not to drive the price of the stock out of their preferred buy range.

"M" Market Direction

The last step, which in my opinion should be the first, ensures that the investor is cognizant of the market's general direction. This also includes understanding of any potential macroeconomic threat that could have an negative affect on the financial markets.

There is a saying that describes the correlation between the different asset classes in the market, a "rising tide lifts all ships". This adage illustrates the point that if you are in a bull market, most stocks will rise with the tide. On the other hand, if the tide is moving out, then it will most likely lower all stocks. This is regardless of how well the individual stock is performing.

 

How to Develop Your Investment Plan

Investing is one of the most powerful elements within the financial planning process. Investing is so important that any financial plan which omits it is doomed to fail. While you can pay a financial advisory firm a bunch of money to invest your hard earned money. I think you should learn how to develop your own investment plan. This way you can take full control of your financial future and avoid a bunch unnecessary fees.

When first starting out, many of us make the mistake of thinking that it takes tons of effort to become a successful investor. I used to spend hours researching companies and trying to craft the perfect portfolio. After a few years of traveling down that road I learned the truth; successful investors only need two things: an investment plan and consistency.

Starting Your Investment Plan

When making your plan, you will first need to understand where you are going. In a financial plan, investment decisions usually stem from the need to save for retirement. However, many couples also invest for their child's future education expenses. Your investment plan can be used to help you achieve any financial goal you have, however for simplicity we are going to use retirement as an example.

The first step when developing your investment plan is to answer the following questions. These are intended to help determine your financial goals and capital needs.

  1. When do you plan to retire (age and year)?
  2. How many years do you have to invest before you need to start making withdraws?
  3. How long do you think you will live after retirement (plan to live until 100)?
  4. How much money will you need a year in order to live well in retirement?

Once you have an idea about how your retirement (or other capital needs) will look, its time to figure out how much you will need to save and invest in order to achieve your financial goal.

Calculating Your Required Savings Rate

The calculation used to determine how much cash you will need to set aside every month is dependent on how much time you have until you need the capital and your anticipated annual return on investment (ROI). To determine your required annual savings rate, I recommend using the Excel spreadsheet function "payment" or PMT. It's simple, just follow these steps:

  1. Open any spreadsheet and enter "=PMT" into any cell.
  2. Enter your estimated annual return on investment (i.e. assume 8% or 0.08).
  3. Input the number of years you have until you need the savings.
  4. Enter a comma, this will bypass the present value parameter.
  5. Input your investment goal future amount (i.e. $1,000,000).
  6. Finally, input a zero for the last parameter.

Your final formula should look like this: "=PMT(0.08,30,,1000000,0)" which equals -$8,827.43. So in this example, we would need to save and invest $8,827.43 a year and receive 8% ROI annually in order to have $1 million in 30 years. Performing these calculations always highlights the power of compounding and starting early.

Crafting Your Investment Strategy

So you've completed the hard part; goals have been established and budget adjusted. Now it's time to put that hard earned money to work. The next step when developing your investment plan is to determine what investments strategies you will need to employ to accomplish your goal.

While portfolio creation doesn't need to be complex; it can get tricky if you let it. The development of a portfolio is beyond the scope of this post, however let the following core investment tenants guide your investment decision making:

  • Build a diversified portfolio (easily accomplished with Exchange Traded Funds)
  • Leverage tax advantaged accounts.
  • Use direct deposit to make saving automatic.
  • Remember why you are investing and your long term goals.
  • Ensure your portfolio's risk profile aligns with your needs.
  • Monitor your investments and adjust as necessary.

Finally, your investment plan is a living document, meaning it should be updated as circumstances change. If you develop and follow your investment plan, there is no doubt in my mind that you'll be better off for it.

 

 

The Tale of Two Stock Trades

Sometimes you win, sometimes you lose. The most important part of stock trading is that you remember that your losers should be smaller than your winners. If you can learn to manage your trades like this, your win to loss ratio can be less than 1:1 (meaning you can have more losers than winners overall). Over the years I’ve learned a few different ways to manage trades in this manner.

Below you’ll find a breakdown of a pair of recent trades that illustrate my point. Within the past week or so, I opened two positions. Both Palo Alto Networks (PANW) and Starbucks (SBUX) had solid fundamentals and technicals at the time. Unless I am looking for an oversold contrarian trade (such as oil right now), I mainly have my eye on growth stocks. Both of the companies passed my fundamental tests, thus my next step is to look at the charts to determine a good entry point.

At the time PANW had pulled back roughly 15% from its all time high in July. I like stocks that are off their highs since this increases the probability of the price action going my way. Additionally the stock had formed a bullish pennant which gave me the “green light” to put some capital to work.

Over the next few days, PANW shot straight up (well, pretty much). So in order to ensure that this winning trade didn’t turn into a loser, I placed a stop order at the top of the gap to lock in my gains. At the time of this writing, the trade is up 18%. Keep in mind that most trades do not go in your favor this far and fast. An earnings release and reported projected growth rates had a lot to do with the price action shortly after I initiated the position. This one is still open.

The next trade didn’t go so well, it actually was a quick loser. I bought SBUX for most of the same reasons I bought PANW. The only difference being Starbucks growth potential isn’t as rapid as Palo Alto Networks. SBUX was off its highs and was consolidating in a ascending pennant. Additionally, SBUX had just bounced off the 50 day moving average twice before. Due to this price action and decent fundamentals, I expected price action similar to PANW.

Once the buy order was filled, I placed a stop order to sell the stock if the price sunk a dollar below the 50 day moving average. I figured that if price fell below that level, the chart and trade was broken and I didn't want to be in it. Well the very next day, SBUX sold off (with the rest of the market) and my stop order was triggered and filled. Over all I lost 2.3% on the trade; easily recoverable.

I hope this example illustrates the importance of trade and risk management. Before you get into a trade, know at what point the trade is broken and determine how much you are willing to lose if you’re wrong. Keeping your trade losses as small as possible will keep you in the market. If you spend more time trying not to lose money, the rest is will take care of itself.

Build an Easy ETF Portfolio

If you want to build an easy ETF portfolio, you're in luck! There are tons of financial products that will allow you to build a simple and efficient portfolio. Today's information rich environment will also allow you to turn the task of building a portfolio into an arduous and time consuming endeavor.

Building a portfolio shouldn't be difficult, and in my experience the time and energy it takes to build a complex portfolio isn't even worth it. Most mutual fund managers lag the market in terms of performance, chances are you will too. So if you're like me and don't want to waste a bunch of time, feel free to follow along and build your portfolio the easy way.

First, Determine the Right Asset Allocation

According to Modern Portfolio Theory, one of the key elements to consider when building an efficient portfolio is the mix of asset classes. Asset class mix can be described as the percent of your portfolio dedicated to particular asset classes.

In this first step we need to determine how much capital we should allocate to stocks, bonds, commodities, options, futures, etc. To keep this portfolio simple we will first look at a portfolio comprised of only stocks and bonds. Then we will discuss other assets classes, such as gold and real estate, that we can add to our portfolio to increase diversification.

The quickest way to determine a "good enough" asset allocation for an individual is the "100 minus your age" rule of thumb. To use this rule of thumb to determine what percent of your capital should be invested in stocks, just subtract your age from 100. The resulting number will be the percentage of your portfolio that should be allocated to stocks. The remaining balance should be allocated into bonds.

Second, Use ETFs for Diversification

Now that you know what percent of your portfolio should be invested into stocks and bonds, its time to find the specific assets to place into your portfolio. As mentioned earlier, the abundance of financial products makes this an easy task. To achieve a "good enough" diversification you only really need to purchase the following Exchange Traded Funds.

Vanguard Total Stock Market (VTI) - Including this fund in your easy ETF portfolio will allow you to track the performance of the U.S. stock market. This ETF includes large, mid, small and micro-cap stocks.

Vanguard Total Bond Market (BND) - This fund will enable you to track the performance of the Barclays U.S. Aggregate Float Adjusted Index. It includes both government and corporate bond issues with a maturity of more than one year.

    I told you this was the World's easiest portfolio! However, if choosing a stock allocation based on your age and only investing in two ETFs is too easy, you can choose to add a few more asset classes to increase your diversification. To add more complexity to your easy ETF portfolio, I would consider dedicating a small percentage of my portfolio to each of the following international, real estate and gold funds.

    Vanguard Total International Stock (VXUS) - This ETF will add international stock exposure to your portfolio. This fund tracks the FTSE Global All Cap and excludes U.S. stocks.

    Vanguard REIT (VNQ) - This ETF will allow you to diversify into real estate investments by tracking the performance of the MSCI U.S. Real Estate Investment Trust (REIT) Index. This index represents roughly 85% of the publicly traded REIT market.

    SPDR Gold Shares (GLD) - Investing in a gold fund will introduce a commodity into your portfolio while providing a good hedge against inflation. The SPDR Gold Shares ETF seeks to track the price performance of gold bullion (net of management fees).

      If you want to get a little more complex and tailor your portfolio's risk and reward profile, you can choose to allocate your stocks based on different sized companies (i.e. small, medium and large capitalization). The following funds can help you customize your easy ETF portfolio based on your individual risk and reward preferences.

      Vanguard Large-Cap (VV) - Include this fund in your easy ETF portfolio if you want an additional allocation to large companies. This fund has a moderate risk and reward profile.

      Vanguard Mid-Cap (VO) - Investing in this mid-cap ETF will increase your exposure to companies with a higher risk and higher reward profile than larger companies.

      Vanguard Small-Cap (VB) - If you want to increase the potential to outperform the S&P 500 and the Dow Jones Industrial Average, increase your allocation to small-cap stocks. Keep in mind that small companies are historically more sensitive to macroeconomic performance.

        Third, Maintain Your Easy ETF Portfolio

        Once in a while you will need to measure how "out of balance" your portfolio has become; in most cases once a year fine. Your easy ETF portfolio will need to be adjusted for two reasons. First, your portfolio's positions will gain and lose value at different rates over time. This will throw your allocation percentages off. Second, as you near retirement you should be reducing your exposure to riskier assets, such as stocks and increasing your allocation to bonds.

        To re-balance your portfolio, determine what percent your stock and bond allocations should be by using the "100 minus your age" rule. Once you have determined where your allocation percentages should be, calculate the size of your current allocations.

        If your positions are larger then they should be you need to "trim the positions". In other words, you will need to sell enough shares to reduce your allocation to where it should be. The gains from trimmed positions should be used to increase allocations (buy more shares) of positions that are smaller than they need to be.