Johnson & Johnson (JNJ), GlaxoSmithKline plc (ADR) (GSK): 3 Reasons Warren Buffett Hates Biotech

I haven’t ever heard him say it directly, but it’s pretty clear that Warren Buffett has no interest in buying biotech companies. I don’t know of any small drug company that Berkshire Hathaway Inc. (NYSE:BRK.A) has ever invested in.

It’s not that he avoids the health-care industry altogether. Berkshire owns shares of big pharmas: Johnson & Johnson (NYSE:JNJ), Sanofi SA (ADR) (NYSE:SNY), and GlaxoSmithKline plc (ADR) (NYSE:GSK). And it owns shares of DaVita HealthCare Partners Inc (NYSE:DVA), which runs dialysis centers.

Johnson & Johnson (JNJ)

But despite the potential monster returns, the Oracle of Omaha has avoided buying smaller biotechs. Here are a few quotes that might explain why.

“Never invest in a business you can’t understand.”
Buffett has admitted to not following the pipelines of the pharmaceutical companies he owns. That’s OK for larger companies, where the growth of the drugs currently on the market has a large influence on the valuation. One pipeline success or failure isn’t going to make or break Johnson & Johnson (NYSE:JNJ), with $67 billion in annual revenue, or GlaxoSmithKline plc (ADR) (NYSE:GSK), with $40 billion. Adding a $1 billion blockbuster will increase revenue by less than 5%. Smaller drugs affect the top and bottom lines by even less.

Biotechs, on the other hand, live and die by their pipeline. Whether it’s their first, second, or even third drug, the additional revenue is huge. If you’re going to invest in biotechs, it’s critical to understand the drugs in the pipeline, where they’re at, their likelihood of success, potential sales, competition from other drugs on the market and in other companies’ pipelines — and the list goes on.

If Buffett doesn’t want to put in the time to understand the nuances of the sector, I think he’s right to stay away.

“Our favorite holding period is forever.”
Even if Buffett wanted to put in the effort to learn the science — and he’s a smart guy, so I’m sure he could figure it out — this Buffettism would make it difficult for him to make a purchase. A vast majority of biotechs swing from way undervalued to way overvalued, often over a very short time frame — think months — certainly not forever.

And there’s a big difference between a development-stage biotech and a commercial-stage biotech; A company that might be great at developing drugs isn’t necessarily one that can sell them well. Dendreon Corporation (NASDAQ:DNDN) is a perfect example. Many investors thought its prostate cancer treatment Provenge wouldn’t work. The FDA rejected it, asking for more data. The second trial proved that Provenge extended patients’ lives, and shares shot up from under $3 to over $50 on FDA approval. Now, three years later, the company sits under $5, paralyzed by sales that didn’t live up to expectations.