- After momentum investors fall out of love with a stock, value investors can achieve big gains.
- Assuring the sustainability of a business is the first critical piece of the puzzle.
- Understanding what created the opportunity is necessary in order to assess potential risk.
- Find the indications that the selling is over, the price has stabilized and it now offers compelling value.
I have had many friends and acquaintances over the years who are great fans of momentum investing and love to tout the enormous profits that can be made very quickly. My concern with momentum investing is that it has always impressed me as simply a bet on being able to find someone dumber than I am who will pay an even higher price for a stock, without any consideration given to the real intrinsic value of the business. There are two reasons this approach has always concerned me in terms of allocating my own capital using the technique. First, I do not recall having ever seen a momentum stock reach a high level and then slow to a smooth rate of sustainable growth; they always seem to crash badly. The second, and most important reason, is that it is very easy for me to see how I could lose a LOT of money hoping to find other people who still have any money left to invest and are dumber than I am.
My basic instinct for self-preservation drove me toward value investing. Oddly enough, it is not uncommon for me to end up owning stocks that have formerly been darlings of the momentum-investing crowd. That is the situation I believe I have found today in shares of Insys Therapeutics (NASDAQ:INSY).
What Makes The Business Sustainable?
From my perspective, the number one issue to consider prior to allocating capital into any investment is to assure myself that the business is sustainable. Do they have a product or service that is a necessity for their customers and are they assured of retaining their customers or being able to replace them on a regular basis while also having a reasonable expectation for increasing the customer base?
In the case of Insys, the company has only two marketable products at this time; but, they are two products that appear to be assured of a continuous and growing demand. The demand will always be driven by new customers as the products Insys provides are only required on a temporary basis by its customers as they will either get well, or die. You see, Insys' two drugs are used to help cancer and AIDS patients.
Subsys is a sublingual fentanyl spray prescribed for breakthrough cancer pain (BTCP) in patients who have become opioid-tolerant through extended use of pain medication. It provides very sick, and often dying, cancer victims with at least some small degree of relief from horrible pain and suffering. Sadly, even though great progress has been made in the treatment of the disease in its various forms, it still remains a disease on the rise and its victims need the relief from pain that Subsys can provide.
The second product that Insys sells is Dronabinol SG Capsule; which is a generic version of the anti-nausea drug Marinol. Marinol is an approved second-line treatment for chemotherapy induced nausea and vomiting and, most importantly, it works. In my case, it was the only thing that worked; it allowed me to keep enough nutrients in my system to prevent starvation during my treatment for lung cancer. When you are so sick you cannot even look at a glass of water with vomiting and do not want to smoke anything because you already have lung cancer, this type of drug is a Godsend. Dronabinol is simply the less expensive generic version of the same drug. Dronabinol is also prescribed for AIDS patients to help stimulate the appetite and food retention of those who are experiencing anorexia as a symptom of that disease.
As with cancer, AIDS does not appear to be likely to go away any time soon and again, even though progress is being made, the supply of new patients seems to be endless for the foreseeable future. The American Cancer Society projects 1,665,540 new cases of cancer will be diagnosed in 2014 and the number of cases in the US is expected to rise almost 50% by 2030. The World Health Organization estimated the number of worldwide cancer cases diagnosed in 2012 at 14.1 million and rising.
Since one of the most common side effects of chemotherapy is severe nausea and Dronabinal is one of the most effective treatments for that nausea demand for this portion of Insys' product offerings should be secure and continue to grow.
For patients who are not fortunate enough to achieve remission or cure through the various treatment options available, cancer does not tend to provide for a peaceful or comfortable end. The pain tends to be prolonged and severe enough that patients develop a high tolerance to the opiate based narcotics that are prescribed to relieve it. That is where the need and market for Subsys comes into play. Unfortunately, the rising number of cancer cases will obviously result in more patients in need of pain relief in the final stages of life and Insys will benefit by selling the product that helps to alleviate that pain.
The year over year sales growth from $15.48 million in 2012 to $99.29 million in 2013 is quite illustrative of the explosive demand for the products provided to the market by Insys. As cancer and AIDS cases continue to rise, so will the demand for these products and the profits derived by Insys.
Understanding The Creation Of The Opportunity
When assessing an investment in a former momentum stock that has crashed to earth, it is crucial to identify what caused the crash and whether that crash created a permanent impairment to the intrinsic value of the business. In the case of Insys, the stock became a victim of its own success coupled with investor panic following the public disclosure of an unfavorable news item.
On March 4, 2014, Insys' share price reached a split-adjusted high of $57.91/share and was trading at an exorbitant 50.35 times 2013 earnings. Even for a growth business, this is a very high valuation and would be difficult to maintain. Considering the stock had risen from a 52-week low of only $11.49/share on August 12, 2013, it would not be an understatement to describe the increase as meteoric.
As I stated at the outset, momentum stock rises tend to all end badly for the last investors who jump on board and the Insys story was no different. By May 8th of this year, the stock price closed at $39.31; a precipitous drop of more than 32% in just over 2 months. As stunned shareholders wondered what had gone wrong, Dr. Gavin Awerbuch was being arraigned in federal court on charges of Medicare fraud and improperly dispensing a control substance.
It was disclosed in the hearing that Dr. Awerbuch had allegedly written the prescriptions for up to 20.3% of all the Medicare covered prescriptions for Subsys between January 2009 and February 2014. By May 15th, the stock had crashed another 47.8% to a low of $20.52 as panic set in and shareholders rushed toward the exit and sold shares at any price available.
Why Should We Believe The Market Reaction Is Wrong?
What they failed to realize or consider was that, if the charges against Dr. Awerbuch were true, they might mean the company would sell less Subsys in the future, but the company was not accused of any wrongdoing in the case. As explained in the May 12th clarifying statement issued by the company, Insys sells its product to wholesalers who handle the distribution of their drugs for them. The statement also reveals that in 2014, no single doctor has written more than 5% of the total prescriptions for Subsys. Dr. Awerbuch might, or might not have committed Medicare fraud; but, Insys had no involvement in prescribing the drugs and therefore no involvement in the alleged crime. Another fact that seemed to have been lost on panicked shareholders is that the company has stated no single doctor has written more than 5% of the total prescriptions for Subsys. Given that Subsys is not the only product that Insys sells, Dr. Awerbuch's alleged misdeeds would have to account for much less than 5% of the company's sales in an absolute worst case scenario. This is a far cry from anything close to justification for a 47.8%. Overreactions of this nature are common in the market and are often the source of exceptional opportunities for those who can remain calm while other sell in fear.
That is encouraging information; it is not enough to justify the allocation of my hard-earned money. Between May 15th and June 16th of this year, key insiders have purchased 66,500 shares of the stock in the open market for a total investment of $1,610,837.66, an average cost of $24.908/shares and a high price of $26.13/share. Clearly, those in a position to know best, were willing to buy in the face of complete and total chaos related to the stock price and do so with a great deal of confidence and conviction. It is important to note that the insider buying began on the exact day the stock price bottomed. They had far more knowledge of, and confidence in, the business than did I. However, the stock has now rebounded to its current price around $30/share and the fundamentals appear to be sound and shouting value.
We Must Always Define The Real Value Prior To Acting
Based upon a review of the fundamentals and reinforced by the conviction of company insiders who are putting their own capital to work here, Insys begins to look like an attractive value proposition when its future prospects are considered.
The only analyst covering the stock with projected earnings is predicting that the earnings will grow at an annualized rate of 24% for the next five years. Based upon the estimated earnings figure of $1.98/share for next year, we are presented with a forward P/E of 15. However, as of March 31, 2014, the company currently had cash, receivables and inventory of $85.4 million and total liabilities of only $24.9 million. This leaves a net cash value of $1.77/share on the books. When this is subtracted from the current share price of the stock, the forward P/E multiple is reduced to 14.25 times 2015 earnings. Based purely on this one metric, I would assess the value of the company at $39.60/share, or 20 times 2015 earnings. Over the last 4 reporting quarters, the company has exceeded the analyst's estimated earnings by 29.63%, 20%, 54.55% and 88.89%.
In terms of building shareholder value, the management team at Insys has performed in a stellar fashion over the last 18 months. At the end of 2012, total shareholder equity in the business amounted to a paltry $18.7 million. By March of this year, shareholder equity had exploded to $97.3 million. This kind of growth is not unheard of in relatively small businesses and some niche markets; but, it is quite noteworthy and indicates the talent and ability of the existing management team when it comes to building real shareholder value.
A growing need for a company's products, rapid growth rate of shareholder equity and heavy insider accumulation are about the best indications investors can look for in terms of limiting the potential downside risk in an investment.
Final Thoughts And Actionable Conclusions
In the end, we have before us a business that will acquire a steady supply of new customers for its products due to the inevitable continuation of the maladies its products help to treat. The share price has been decimated as the company lost favor among momentum investors and then was hit with a misunderstood connection to a Medicare fraud case. Heavy insider buying in the open market coincided with the recent low in share price and the stock has moved up strongly. The company has a solid balance sheet with few liabilities compared to its liquid assets.
The company is scheduled to report its second quarter earnings on August 12th and many investors have a strong predisposition against buying right in front of an earnings announcement. As a value oriented investor, I do not tend to have those concerns as my capital allocation decisions are not based on a single quarterly earnings report but upon my assessment of intrinsic value compared to current price. We should also keep in mind that the corporate insiders were buying shares in the second half of the second quarter when they would surely already have a good idea as to what the final results would be.
Buying Insys now should result in long-term annualized gains of 15% to 20% a year for many years to come. Cancer and AIDS are not going away anytime soon and neither will the need for the products provided by Insys.