Dear fellow investors,
In the aftermath of the influx of illegal drugs into the U.S. in the 1980s, former First Lady Nancy Reagan led a campaign against drug use called “Just Say No.” In 1994, while at Smith Barney, our pharmaceutical analyst did a branch tour because her research piece used the same title. Her recommendation was to stay away from investing in pharmaceutical stocks.
Her sell recommendation couldn’t have been more poorly timed. Beginning in 1994, the pharma stocks were a great place to invest for decades. Her pessimism about industry difficulties was well researched but had been deeply priced into the stocks. We took full advantage back then and loved our contrarian circumstance.
Ironically, in 2004, one of the stocks that looked the most interesting was Merck (MRK). They had created an extremely effective painkiller called Vioxx. However, they resisted a label that warned of the side effects and were forced to pull the product.
This time, the fears are related to losing patent protection on their most successful cancer treatment, Keytruda. Merck is as cheap today by almost any measure as it was when they were forced to shut down their best-selling drug!
Thanks to pressure from the new Trump administration, the pharmaceutical stocks look somewhat as deeply out of favor relative to the S&P 500 Index as they were in 1994. For political reasons, the new administration is looking to bring inflation down. The persistent inflation from the massive $12 trillion of U.S. Treasury borrowing done to get us through COVID-19 seemed to doom any reelection possibilities for President Biden. Therefore, President Trump wants to get Republican candidates elected in the midterm elections. To him, driving down drug prices (and oil prices) is the way to gain favor with voters.
It took me three weeks of political science classes in 1976 to switch from that major to economics. In my 45 years in the investment business, buying out of favor meritorious companies when the politicians are hassling them has been one of our lifeblood’s. Think banks in 2012 when politicians were Occupying Wall Street and mall REITs (nobody is going to stores anymore) in the 2020 COVID-19 shutdowns.
Let’s compare Merck to the S&P 500 Index by a few valuation methods over the decades:
Source: Bloomberg.
Source: Bloomberg.
Compared to most stocks, Merck is a bargain, and we are looking to take the most advantage of what we view as a major mispricing in the sector.
Play The Long Game,
William Smead
The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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