One thing that many investors become fixated on is always wanting the next ‘hot tip’ or the ‘inside word.’ Forever seeking an edge on everyone else, investors seek the holy grail of critical company knowledge that will allow them to score that big profit.
What about if we considered the following? Instead of trying to figure out which is the most undervalued company; we focus on how we can best apply a bullish view on a company? We ask ourselves, how can we apply a bullish view that is linear in its downside and non-linear in its upside?
What I mean by this is how we apply a view that if we are wrong we lose $1 but if we are right we stand to make considerably more than $1? Or put another way – how we have leverage on the gains but not the losses?
I believe we can achieve this ‘linear loss / non-linear win’ payoff profile using long dated call options on stocks with relatively low volatility. I have shortlisted 3 stocks in the pharmaceutical industry that I believe have good long term prospects and still the capacity to surprise on the upside.
Merck & Co., Inc. (NYSE:MRK)
A big player in the pharmaceutical world, Merck is a powerhouse when it comes to producing drugs that sell by the millions.
What I like about Merck’s prospects is their CEO’s attitude to investing in drugs that have the potential to be ‘real game changers.’ I recently came across an interview with CEO Kenneth Frazier. He was questioned about the viability of Merck & Co., Inc. (NYSE:MRK) investing heavily into R&D for Alzheimer’s drug research. Frazier responded with saying, ‘Isn’t that exactly what the world wants a company like Merck to do?’
As an investor, this is the attitude I like to see from a CEO – a willingness to back his team to invest in projects that have the potential to produce enormous, outsized profits.
Merck & Co., Inc. (NYSE:MRK) may well spend tens of millions in R&D for a successful Alzheimer’s drug. A successful drug will likely mean many billions of dollars in additional revenue.
Pfizer Inc. (NYSE:PFE)
Pfizer is a giant in the pharmaceutical world with a market cap of over $200 Billion. Pfizer Inc. (NYSE:PFE) is currently trending quite nicely, Yet still conservatively valued. With a Forward P/E of less than 12 and a dividend yield of over 3%, Pfizer is by no means overvalued.
Pfizer has until recently faced the headwind of Lipitor coming out of patent. However Pfizer seems to be showing it can survive and improve even as flagship products like Lipitor patents expire.
With 17 molecules in Phase III Trials, to me Pfizer only needs to have a success rate of 2 out of 10, and all of a sudden 3 drugs are approved and in a position to generate substantial revenue.