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Application of Investment Theory on Individual Stocks

Individual stock returns are random, assets are priced efficiently, all available information is known by all investors, you can’t beat the market. How is an investor today supposed to make a profit? When the greatest investors around the world are making near twenty percent returns how are individual or non-institutional investors supposed to make a return. Individual part time investors are doomed from the start and even more so doomed if you are a trader. The idea that a single person can outperform an entire investment firm or even a single person that does this practice for a living is crazy. It’s like me putting my life savings on a one versus one match against Lebron James it’s just not possible for me to come out on top, in many cases it’d be more realistic for me to say the entire Cavs team. Why would I even want to be an individual investor, there is no reason to put my own money at risk. Investing has been around forever, but has become a life commitment today when you look at how different and diverse investments can get.

This paper will look to bring focus practical ways to analyze individual stocks and start to make a portfolio. To understand my thought process and methods from which I analyze stocks in this you have to understand Martin Shkreli’s approach which I have adopted much of it. First you have to start with his logical road map, you have to be realistic. As I mentioned above it is unlikely a poor college student will be able to outperform the likes of Warren Buffet, Carl Icahn, and George Soros. In fact Shkreli emphasizes not even getting involved in the stock market usually. Most of your money throughout your lifetime will be made on some sort of fee basis. Hence you are better off advising people with money how to invest it than put your own money at risk. This advice must be worthwhile and have some type of meaning behind it. Shkreli for example has a complex understanding of the pharmaceutical industry having started his own pharmaceutical company and owning two different ones in his career, Shkreli understands the industry in a way that few people do. Specialization in a field is necessary then to make this advice worthwhile.

Shkreli’s investment process and analysis involves analyzing the three “holy trinity” of financial statements. These statements include the income statement, balance sheet, and statement of cash flows. He values companies in the same way a financial manager would in that the value of a company is worth the sum of all discounted cash flows from operations until eternity using net present value. Shkreli uses a fundamental approach to investing, part of which he adopted from Phillip Fischer in his book Common Stocks and Uncommon Profits. In doing so he believes a proper investment decision comes after spending near one thousand hours understanding a company. Some approaches Shkreli uses aren’t exactly widely adopted. For example Shkreli believes that stocks do not go up in the long run when you adjust for inflation and taxes.

Waste Management (WM)

Waste Management is one of the largest waste and environmental service companies in the U.S. headquartered in Houston, Texas. In the northeast almost, all large waste containers and dump trucks have the Waste Management logo. Clearly they have a huge presence and without any understanding of their company let alone stocks in general you would expect the company to be worth a lot. With a price of $80.92 as of 11/21/17 and 442 million shares outstanding of common stock it has a market capitalization $35.837 billion, so yes Waste Management is worth a significant amount when you look at their market capitalization. When you subtract cash and add back debt you get the enterprise value of $44.849 billion. I will be using enterprise value in my calculations versus market capitalization. Why? When you buy stock in a company you are actually buying part of that company and the rights to their assets and net incomes that come from operations. Market capitalization is a poor measure of value when compared to enterprise value as it does not consider debt and cash.

MC + Debt – Cash = EV

For example if I was looking to buy a company with a market cap of $100, debt of $5, and cash of $75 my enterprise value would be

100 + 5 – 75 = 30

Even if I pay the full market cap price of $100 for this company it’s really like I am paying $30 because they have little debt $5, and a lot of cash on hand $75. If I flip this around though the opposite happens

100 + 75 – 5 = 170

In this situation when the debt is equal to $75 and cash equal to $5 the enterprise value becomes $170. If I were to pay the full market cap price of $100 I would not be happy. ¾ of this company is debt I would want to be compensated for the risk associated with that. I would not want to buy this company unless at a far discounted price from their market price.

Once I have my enterprise value in my model I begin entering the numbers from the income statement in. Generally I want to have every quarterly and annual financials in my model but in this case I opted to 3 years of quarterly statements and 14 years of annual statements. When reviewing WM income statement some of the first things you might notice is that they make large amounts of revenue at well over $3 billion the past 12 quarterly statements and that they have done this the past 14 years as they’ve been making close to $13 billion on average over the past 14 years. When you look at their net income though you can see they are only making $0.10 on every $1 they make in revenue if that. So clearly this is a very capital-intensive industry and a high cost industry. Industries like this make way for monopolies and oligopolies to be possible. There are extremely high barriers for other firms to enter this market due to the high costs, in this situation we expect WM to have a large market share in the waste industry, which they do at almost 30% of all waste collection, 47% of all landfills, 63% of all transfer stations giving them a total share of around 37%.

Waste Management Income Statement Analysis

Still working on written portion

Alexion Analysis

Still working on written portion

 

 

 

 

 

 

 

 

Axovant Sciences Write Up

Axovant Sciences is a clinical stage bio pharmaceutical company that commercializes therapeutics for neurodegenerative diseases. Axovant was founded in 2014 as a subsidiary of Roivant Sciences, they have offices in Bermuda, Switzerland, and London. Axovant has two products as possible treatments for lewy body dementia, Intepirdine and nelotanserin. Intepirdine has just recently failed a pivotal phase III clinical trial showing no efficacy. Intepirdine is Axovant’s number one drug candidate for the treatment of lewy body dementia. Intepirdine was acquired from Glaxo Smith Kline in 2014 for $315 million. Idalopirdine is a class similar drug to Intepirdine that failed all three of its clinical trials and did not have positive efficacy. Glaxo Smith Kline also sold Axovant this drug candidate after it had failed their own clinical trials.

Axovant currently doesn’t have much of a position in the treatment of neurodegenerative diseases. They number one drug candidate Intepirdine has no efficacy and Nelotanserin is still only in phase II clinical trials. Axovant acquired all the rights of Nelotanserin from Arena Pharmaceuticals last year. If Nelotanserin proves to have efficacy and gets FDA approved, it will be one of the first treatments used for lewy body dementia (alzheimer’s disease) with donepezil a current FDA approved treatment for lewy body dementia. Some competitors and peers in the industry of neurodegenerative treatments include Amgen, Nova Nordisk, Gilead, Celgene, Biogen, Shire, Vertex, and Incyte. All of which are far less speculative and more diverse than Axonvant.

In the neurodegenerative therapeutic industry, the current FDA approved drugs include Donepezil, Galantamine, and Rivastigmine, all of which are acetylcholinesterase inhibitors. Intepirdine is a 5-HT6 receptor antagonist, as I mentioned above Idalopirdine is a 5-HT6 inhibitor failed all three of its clinical trials. Currently Axovants entire company is relying on the approval of their 5-HT2A receptor drug Nelotanserin’s approval, even though they have already burned much of the cash from their IPO on getting Intepirdine approved.

It seems unlikely Axovant will have much success now or in the future. The current best-case scenario is for Axovant to continue the clinical trials for Nelotanserin and hope it shows efficacy. Though it seems unlikely they will be able to continue spending money on the production and approval of Nelotanserin. It seems more than likely that if Nelotanserin ever makes it into the neurodegenerative therapeutic market that it will be through another company if it is acquired.

The current CEO David Hung who has had previous success building the drug company Medivation which was later sold to Pfizer for $15 billon says he has no interest in being acquired. Hung stating he is focused on true innovation not creating new versions of drugs that have already been made. One of his main focus being his employees who he seems to have the utmost confidence they are competent to get the job done. If Hung truly does believe Nelotanserin will be successful than it seems likely he will be able to find investors to put money into it. Axovant’s stock price dropped significantly after the phase III results of Intepirdine from the mid $20s to almost $5. It has since continued to drop falling below $5.

Axovant Sciences Ratio Analysis Comparison to Gilead Sciences

Using both Markteline and Morning stars rich amount of information to compare the ratios I found for AXON gives a very bad outlook for future performance of AXON. Especially when compared to GILD which is probably an unfair comparison for AXON currently as AXON is a small speculative company that has yet to get a product on the market, while GILD is a well-developed bio-pharma giant. Regardless GILD was not long ago a small company trying to get it’s first drugs approved. To begin AXON’s profit margin is non-existent since they have yet to get a product approved. They have been burring through cash attempting to get their first product Intepirdine approved which has just recently failed a phase III clinical trial. GILD on the other hand has a very high profit margin of around 86% which is very favorable. Both return on assets and return on equity are negative for AXON as well. Which is unfortunate for shareholders who are earning negative amounts when it comes to profit per dollar of assets (ROA) and negative amounts of profit per dollar of equity (ROE). GILD on the other hand has some favorable numbers for their ROA at 24% and ROE at 71%. The fact that GILD’s ROE is much higher than their ROA suggests they are using financial leverage. Being a new player in the bio-pharma market AXON has a very high quick and current ratio, at 17.9 for both, AXON can cover all their current liabilities 17.9 times over. AXON could easily be liquidated very quickly which is common for new bio-pharma companies that are still trying to start earning revenue. This can be looked at positively or negatively, the fact that both ratios are above 1 is positive, but that fact that it Is 17.9 times could be looked at negatively. GILD has healthy quick and current ratios at 2.05 and 2.22 meaning they have their liabilities covered 2 times over even when even if you were to minus off their inventory. AXON’s debt-equity ratio is currently 0.41 as they have just started taking on long term debt this past year. Some might view this as positive which in some ways it is, because every healthy company usually has some level of debt. However, AXON currently has no revenues so the fact that they have a debt-equity ratio of 0.41 with not FDA approved product is not very good. For a company trying to get their first product FDA approved it is important they have a lot of cash on hand, so they can pay for clinical trials and other costs that come with the process. Once they have a product FDA approved we should expect them to get some level of debt or royalty payments by setting up manufacturing and distribution deals, or starting their own manufacturing or distribution. Inventory, asset, and receivable turnover ratios are all 0 for AXON because AXON currently has no sales or cogs. GILD on the other hand has an inventory turnover of 2.66, receivable turnover of 6.73, and asset turnover of 0.53. Having a high inventory and receivable turnover ratios is desirable. GILD has just that, the high inventory turnover rate meaning inventory is not sitting around, and high receivable turnover rate meaning they are able to get their receivables payed back quite fast. Which can be a hard thing to do in the third-party payer system we use to pay for most of these products by insurers. The asset turnover ratio for a company like GILD is healthy, for every dollar in assets GILD generated 0.53 cents in sales. Bio-pharma is a capital-intensive industry, but not as capital intensive as say an Eversource energy which would have much more money in assets and a higher asset turnover ratio than GILD. AXON has a negative earnings per share ratio, again because they currently have no sales and are spending cash on operating expenses. A lower PE ratio suggests a firm could be undervalued, though a higher PE ratio might suggest investors believe there is growth to come in the company. GILD for example has a PE ratio of 7.23 which is not very high for a company that is pulling in billions of dollars in revenue with a low profit and gross margin. Many investors may be skeptical of GILD’s diminishing Hepatitis C revenues and whether they can bounce back from losing a large source of revenue. AXON has a price to book ratio of 4.40 which is a desirable ratio to have, GILD also has a desirable price to book ratio at 5.04. A price to book ratio less than one suggests a company has not been successful at creating overall value for its shareholders. Which is surprising because AXON in many ways has done just that with a negative PE and the recent phase III failure. GILD on the other hand has maximized shareholder profits over the years. This exercise has been informative, it showed in some cases how useful financial ratios can be, as well as that sometimes you must be skeptical of the results they produce. AXON in underperformed GILD in almost all the financial ratio analysis. One might think about investing in GILD instead of AXON because of this which would probably be smart.

Axovant Sciences Conclusion

Given the analysis I completed on AXON which included the write up, financial ratios, memo, and a brief analysis of the income statement I would not suggest a friend to invest in AXON. Had intepiridne gotten positive efficacy in their phase III trial and FDA approved this past month it would have been a different story. However their 5-HT6 inhibitor failed to do so, much like previous 5-HT6’s have in the past. AXON could run out of money before 2020 if they continue to spend at their current pace, though they only have one more drug to currently spend money on, which is in a phase II trial. However phase III trials are the most expensive trials and AXON will need cash on hand to pay for it. The best case scenario for AXON is that they get bought by a larger competitor that sees potential in their only other drug Nelotanserin. All of the ratios AXON has to provide suggest in many ways it is not smart to invest in the company and that one would be better off investing in a competitor such as GILD.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Citations

http://investors.wm.com/phoenix.zhtml?c=119743&p=irol-IRHome

http://investors.axovant.com/investors

http://ir.alexion.com/

https://www.sec.gov/search/search.htm

https://advantage.marketline.com

https://jump.valueline.com/

 

 

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