Last month I explained my views on a suitable portfolio structure for early retirees and this month my views on a way to transition a pre-early retirement portfolio to the permanent early retiree portfolio. The proposed portfolio structure was basically a mix of safety and opportunity components: cash, bonds, "opportunity" stocks and dividend stocks.
In this article I would like to present three stocks that could be suitable to fill the "opportunity" segment. I consider them to be suitable mainly because of their "antifragile" aspects. "Antifragile" is a concept developed by Nassim Taleb and characterizes objects that actually benefit from being subjected to stress. Not only do they resist, they even benefit. Applied to businesses, this means that there are companies that can profit from recessions, stock market panics or general disorder. As retirees basically depend more on a stable economic environment than other people, investing in antifragile businesses can be a smart way to manage this problem. In good times they provide stability and bad times bring about nice opportunities.
While the below mentioned companies can't be considered perfect fits, they all check a few important boxes: they don't pay dividends, have rather stable, non-cyclical core businesses and, being run by smart capital allocators, they can benefit from market dislocations. However, I also want to caution potential investors that all these businesses have considerable debt. While this is another way to profit from typical economic downturns with lower interest rates, it is a far riskier position than the basic selections I originally proposed for the "opportunity" segment. Personally, after many days of reading, I decided to buy only one of them - Valeant (NYSE:VRX) - and I bought only a smaller than average position (unfortunately, as the stake has grown so fast that it has become one of my biggest positions). I would also have bought Actavis (ACT) some time ago, while I would not have bought and would not buy for myself Endo (NASDAQ:ENDP) which I consider to be a rather speculative bet. For some investors, with far less concentrated portfolios than mine, there may be a place even for Endo. In any case, before investing in any of the three, please do your own research. The analysis of their accounts alone won't be enough, as these fast morphing companies are like moving targets and in my opinion there is only one way to appreciate their underlying value: through a deep understanding of their core principles and business cultures. This is easier to do in the cases of Actavis and Valeant, because they already have a few years of history to look back on, while Endo has changed its course only recently and the rapid stock appreciation is basically only due to great faith in the new CEO.
All three companies could easily become great compounding machines for your portfolio and are definitely worth some hours of research.
There are some good articles on Valeant here on Seeking Alpha, so I will provide only an essential presentation of what distinguishes Valeant from almost all other pharmaceutical companies. Under the incredible leadership of Mike Pearson, Valeant basically acts as a value investor in the pharmaceuticals sector. While some people compare Pearson to Warren Buffett, I would rather draw a comparison to John Malone. By combining smartly several companies and their respective assets, by profiting from low tax jurisdictions, by spotting high synergy mergers or by optimizing marketing for previously rather badly marketed products, Pearson has created incredible value for Valeant's shareholders and incredibly fast: from the bottom in 2008 investors have multiplied their money almost by a factor of 20.
Valeant strictly focuses on low-risk assets with little to no R&D spending required, no or little risks of not gaining FDA approval and low cyclicality. Hence, focus areas in the pharma spectrum are dermatological treatments, aesthetics and contact lenses. (Human vanity never runs out of money.) Typically, Valeant prefers to invest in products that are not reimbursed by public health systems to avoid price regulations and focuses on the higher growth areas around the globe, largely avoiding e.g. European countries.
As the company is already highly leveraged, there won't be any large acquisition in the next year or so. However, Pearson has frequently stated that he is looking out for a value generating merger of equals, i.e. a combination with another equally sized pharma business that could immediately deleverage the combined entity's balance sheet and create further synergies.
The company currently trades at about 15 times the projected "cash"-EPS for 2014, which is not at all expensive, if Valeant can continue to grow at double digit rates. Investors should also consider, however, that the company's "cash"-EPS measure indicates only potential earning power and not real cash earnings already achieved. So far, year after year, history has never contradicted Valeant's potential future earnings estimates and it is highly likely that the company would really earn the projected cash, if it stopped to invest aggressively in its growth. But there is some risk attached to the rapid growth and Valeant is certainly not as safe a pharma company as Johnson & Johnson (NYSE:JNJ) of Sanofi (NYSE:SNY).
Under CEO Paul Bisaro, Actavis has seen rapid growth not much different from Valeant. Both companies act in a similar way as value investors, with Actavis focusing clearly on the generic segment (which Valeant generally avoids, because it considers generics to be too price competitive). Actavis is currently the world's third largest generic drug manufacturer, hence it definitely has the necessary scale to be able to compete in a market where price is almost the only differentiator between competing products. For some time, Valeant and Actavis were talking about a merger of equals, but in the end the price tag was too heavy for Valeant and Actavis preferred to pursue the Warner Chilcott merger which provided access to a low tax jurisdiction, generating immediately great value for Actavis' shareholders. Nevertheless it is still possible that the two companies will merge in the future.
Personally I also don't like too much a commodity sector like generics and with Actavis' stock trading at similar adjusted 2014 earnings multiples to Valeant, currently I would clearly prefer Valeant. However, if Actavis traded at a large discount relative to Valeant, I would consider a purchase.
Endo Health Solutions
Until about one year ago, Endo was in a very uncomfortable spot. The company had overpaid for a few large acquisitions that did not deliver on their targets and made the vast majority of its profits on drugs that would soon face generic competition. Furthermore, it had a huge debt load with lots of it coming due in little time. The stock traded at very low multiples, as investors expected earnings to decrease sharply in the near future. But then entered the new CEO Rajiv De Silva - formerly President and Chief Operating Officer of the specialty pharmaceuticals branch of Valeant. The simple news of his arrival gave the stock a boost, as investors expected Endo to follow in the footsteps of Mike Pearson's company. Since then, De Silva has already done a few smart things, like the Paladin deal which provided access to the low tax jurisdiction of Ireland and the divestiture of HealthTronics. Now Endo's stock has more than doubled compared to one year ago and trades at similar adjusted earnings multiples to Valeant and Actavis, but its problems are far from solved. Probably De Silva deserves a great deal of trust in his capabilities to turn the company around and generate value for its shareholders and Endo, being far smaller than Actavis and Valeant, could obviously grow far faster - but I would consider this a rather speculative bet as Endo has a comparatively weak product portfolio and the debt load severely limits De Silva's opportunities. However, I generally tend to be hyper cautious and would not rule out a positive surprise. So do your own research on this promising company and maybe you will feel safer than I do and catch the multi-bagger I am missing.
Disclosure: I am long VRX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.