James Maynard Keynes believed the stock market worked something like a beauty contest. In effect, the absolutely best-looking person wouldn't necessarily win the contest, rather the person that the general public perceived as the most beautiful would win. Put simply, Keynes believed that stocks didn't necessarily trade on their fundamentals but on public perception. Perception is reality, under his view.
In a similar manner, George Soro's "reflexivity" concept is in many ways a fancier version of Keynes beauty contest analogy. My neophyte understanding of reflexivity is that the collective belief in something can cause it to happen, regardless of underlying truth. I believe these two paradigms are united by the fact that empirical truth, if there is such a thing, is pushed aside for the power of mass delusion, or put nicer, perception.
Benjamin Graham also weighed in on the often irrational behavior of the market with his dictum, the stock market behaves like a voting machine in the short term, but in the long term it acts like a weighing machine.
So, Graham counters Keynes and Soros' beliefs belief that fundamentals ultimately do not matter.
How do these paradigms apply to biotech stocks in modern times?
Being an avid investor in biotech, I can certainly see the validity of both views. Myriad start-up or developmental biotechs use Keynesian psychology to their advantage, putting out ridiculous value propositions to capture the imagination of the investing public. In reality, however, the company is dirt broke with questionable long-term prospects. More often than not, investors are left holding a worthless piece of paper that they thought was going to make them rich.
By contrast, I've seen a handful of healthcare companies put their nose to the grindstone to create long-term value for their shareholders, eschewing short-term gains. BioMarin (BMRN), Cubist Pharmaceuticals (CBST), and Vertex Pharmaceuticals (VRTX) come immediately to mind, for example.
And what I find most interesting is that none of these three companies have much of a social following, and are generally ignored by the average retail investor. Yet, they have all beat the broader markets over the last five years running. And they've done so in a relatively steady fashion. In short, an investment in any one of these three wouldn't have kept you awake at night, but still would have made you market-beating returns.
For investors that like to jump from stock to stock and play the momentum game, however, the Keynesian/Soros view isn't a bad way to go. In sum, your goal is to get in early and exit well before perception changes.
Armed with these concepts, I'd like to turn your attention to one of the most popular healthcare stocks amongst the retail crowd these days, Ariad Pharmaceuticals (ARIA), as judged by its following on Stocktwits, and consider its short and long-term prospects.
A look at Ariad from the Keynesian and Graham-ian perspectives
Ariad Pharmaceuticals' popularity has rocketed ever since its flagship leukemia drug, Iclusig, was placed on a partial clinical hold by the FDA due to excessive risk of blood clotting. To recap, the stock crashed following the clinical hold, the EMA kept the drug on the market but with a revised label, and the FDA has since reauthorized the drug with a stricter label.
Shares of Ariad have seen tremendous volatility since the crash, but have still rallied more than 200%. While some of this upward momentum is due to material changes in Iclusig's market potential, my view is that the bulk of it has been the result of rumor mongering.
Ridiculous rumors, such as a takeover by Eli Lilly, recently hit the wires causing the stock to jump, and even a non-event such as Sarissa Capital pushing for board members drove the stock up lately. In sum, Ariad's shares have clearly been trading on public perception, not Iclusig's commercial prospects, or the company's overall fundamentals. If you were to go off of the tweets on Stocktwits, you would certainly come to the conclusion that Ariad is going to double any day now.
Backing this assertion, I have even gotten a slew of emails about this very prospect. And to answer those questions here, no, I do not think Ariad is about to double.
Turning to the company's fundamentals and away from the rumor mill, I think investors should keep a few things in mind moving forward. Iclusig is now a treatment of last resort for its current indications after the revised label. As such, Iclusig is no longer expected to be a blockbuster, but instead, should generate around $300 million per year. Ariad shares are thus trading close to five times peak sales for Iclusig, per its current label.
Looking down the pipeline, Iclusig is in the midst of clinical trials for an additional seven indications. Yet, it's important to keep in mind that safety issues will be a huge issue for the FDA with future indications. So, it's hard to see Iclusig being approved in conditions other than those that are terminal, and other treatment options are lacking in some capacity.
Ariad also has an experimental drug in mid-stage trials for non-small cell lung cancer, but again, drugs for this indication are prone to failure in general.
So, what are we left with once we strip away the veneer? I think all that's here is a third-line cancer drug with problematic side-effects, and a clinical program burning cash at an increasing rate. In fact, it's hard to see how Ariad would come anywhere close to cash flow positive within the next five years.
Bottom line on Ariad: The rumors about a buyout are a work of pure fiction, and the company will eventually have to raise funds through dilution. Over the long term, I think Graham-ian views go to work and shares move lower from current levels. In the short-term, Keynesian views will prevail due to the company's cult-like following, pushing shares into the $9-$10 range. In sum, Ariad looks to be a good short-term trading vehicle but a poor long-term value play. So, position yourself accordingly.