How do the best investors detect life science companies with the potential to generate significant wealth? Michael Berry, publisher of Morning Notes, found that traditional growth and value models didn't measure up, so he developed his own "discovery" strategy. He looks at companies that haven't gone public yet. He's not afraid of the penny stock. Find out more about Berry's technique in this interview with The Life Sciences Report.
The Life Sciences Report: Mike, you and I have talked about life sciences investing before. Investing in any sector is difficult, but the life sciences, and particularly biotechnology, are complex. What general advice can you give a growth investor who wants to speculate in micro-cap biotech? Particularly, how does the retail investor intelligently understand his or her investment in a company engaged in molecular biology?
Michael Berry: My style of investing in the life sciences is not really growth investing, George. It's a technique quite different, called "Discovery Investing." I've developed it through the last decade because neither the growth nor value styles really fit the mold in picking winners in the life sciences segment.
But some of the advice is generic. If you want to play in the life sciences space, you must diversify. With FDA hurdles and the expensive nature of preclinical and clinical trials, micro caps tend to burn money quickly. Focus on two or three applications in the life sciences space, and understand that you cannot possibly know everything about those applications. Diversification will dilute those risks.
Another piece of advice is to know the space. If you are interested in stem cells, for instance, find the literature and the top scientists, and get to know them. Many are university professors and really easy to reach out to. If cancer interests you, read the literature. From personal experience, I know that tremendous strides have been made in treatment of skin cancer. Roche Holding AG (OTCQX:RHHBY) has a pill [Zelboraf/vemurafenib] that shrinks melanoma tumors with a high degree of success. This was a Genentech development.
You must be invested in themes that interest you, and that you naturally are attracted to. That makes decision-making so much easier.
Finally, zero in on public-and especially nonpublic-companies in your space of interest. I like to track companies that are not yet public and get to know the management. You reduce your risk of being diluted into outer space, as so often happens. Then use our 10-point grid and the Discovery Scoreboard to grade and rank your companies of interest.
The Internet greatly facilitates all these tasks. It is an interactive research tool investors should take advantage of. There are no excuses!
A word of warning: In this space, investors must be prepared to take profits to manage risk intelligently. That, perhaps, is the more important aspect of wealth creation in the discovery space.
TLSR: Do you look for growth where you can find it? Or do you try to find specific themes in biotech?
MB: In the life sciences discovery space, the broad topics are thematic. Great wealth is created at the beginning of the cycle. Inovio Pharmaceuticals Inc. (NASDAQ:INO), which has a cancer vaccine platform, soared 400% earlier this summer based on the broad realization that new cancer therapy discoveries may be possible.
TLSR: You are not afraid to invest in penny stocks-I mean very, very low market cap stories. Do you have to be an active investor in a company to be involved with a name with a market cap under $5-10 million [$5-10M]?
MB: Interestingly enough, most of these stocks go from penny status to dollar status and back several times in their life cycles. You really have to trade.
We are not afraid of penny stocks. However one of the 10 discovery factors is sustainability. So we look carefully at a company's balance sheet, and its sources and use of funds through clinical trials, to ascertain how well the company can survive. We also look for positive catalysts, and how near and likely they might be. And if management is composed of scientists-so often this is the case and scientists are usually such poor managers-we want to know if they understand the more general management issues involved in taking a product to the market, or generating a monetizing event?
In some markets you must weight your portfolio toward mature life sciences discovery companies, versus less well-known incubator companies that could possibly generate greater wealth. Incubator companies are the most risky because their intellectual property [IP] is not yet as well developed. But such companies often do pay off in great wealth creation.
TLSR: A penny-stock story will most certainly require some dilution. Is that just the price of doing business?
MB: Not necessarily. For example, good general management may be able to take advantage of a market and/or a world-class discovery to effectively dilute, rather than by using the stock market. Too many management teams use the penny market-they could utilize callable convertible preferred securities, which would limit dilution or at least place it under the company's control.
I have written extensively on the strategic use of dilution by management, and the way investors must anticipate dilution, hedging against value destruction from percent [control] dilution. Such dilution tactics, judiciously used, often result in value accretion.
TLSR: Thanks for your time, Mike.
MB: My pleasure, George.
This interview was conducted by George S. Mack of The Life Sciences Report.
From 1982-1990, Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, during which time he published a book, Managing Investments: A Case Approach. He was the Wheat First Professor of Investments at James Madison University. He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.
1) George S. Mack conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an employee or as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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3) Michael Berry: I own or my family owns shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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