Biotech, Solar, and Hot Dogs--Listener Questions Answered

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Welcome to the Barron's Streetwise Podcast listener question edition. I'm Jack Howe. Typically on this podcast, we look into a particular subject, maybe talk with a big company chief or other guest, and then I answer a listener question. But this week we're doing nothing but listener questions because for one thing, we've compiled quite a few of them, and for another, our audio producer Meta, listening in as always, is going on vacation. Hi, Meta.

Hey, Jack.

I'm not going to tell everyone where you're going because I know they will all meet you there to say hello because our listeners love you. But I'll just say beaches, lighthouses. I'm going to guess big hats, umbrella drinks.

Yes.

Have I said too much? No.

Let's throw in sandcastles.

Good. Now, I just want to mention, Meta, that I'm using this new microphone that you sent me. I broke my original microphone. I don't know how someone breaks a microphone podcasting, but I did. And in looking at the manual, apparently I've been using the microphone wrong for the past 6 months. You're not supposed to hold on to it like you're eating an ice cream cone. So sorry for that. How do I sound?

You sound good, and I think you just wore your old microphone down from all the effort of podcasting.

Let's put some mileage on this microphone and get right to our first question. Who do we have?

Our first question is from Or, who says he's doing a PhD in biomedical sciences.

Hi, Jack and Metta. I'm a big fan of your podcast, been listening since the beginning. My question is about the biotech stocks.

He says he feels comfortable judging for himself whether the science behind them is sound, but he's unsure about how to size up the financials.

When you go look at the financials, it's all over the place, and I don't know what What's the right way of judging this company compared to other companies in the sector or in the market as a whole? What do you suggest I do?

Thank you, Or. Your question is about biotech drugs. And for anyone who doesn't know what those are, they're drugs that are made by manipulating living things. You can think of drugs as being divided by chemistry and biology with a little bit of overlap. For example, Alka-Seltzer, which was launched almost 90 years ago, is a clear example of a drug that comes from chemistry. It's basically a mix of aspirin and baking soda, with a third ingredient to make the tablets fizz in water.

Plop, plop, fizz, fizz, oh what a relief it is.

You remember the old ads? Plop, plop, fizz, fizz, oh what a relief it is. If it wasn't for that third ingredient, it would have just been plop, plop, oh what a relief it is, which I don't think is going to sell product, honestly. Anyway, that's drugs made from chemistry. Now think about penicillin. That comes from something living. Mold, and it's made in much the way that beer and wine is made in big fermentation tanks. So there's biology involved, but the term biotech is applied generally to cases where living things are being altered. Earlier this year, we had Len Schleifer on the podcast. He's the chief of a company called Regeneron, and they have a drug platform that uses mice that have been genetically modified to have human immune systems. If you introduce viruses to those mice, they can create human antibodies, and those antibodies can be used to treat people. Regeneron is currently testing a new treatment for COVID-19 that was made using that platform. It's a clear example of a biotech drug. Okay, so, or you can judge a mature biotech company much like you would any manufacturer by the free cash it produces and is likely to produce in the future. For example, a poll of Wall Street analysts suggests Regeneron is likely to produce close to $2.9 billion in free cash this year, rising to $3.4 billion next year. You can compare that figure with the company's stock market value. Regeneron shares have been on a tear recently. They had more than doubled over the past year, and the stock market value stood at about $65 billion. So Regeneron traded at 19 times next year's projected free cash flow. You can judge for yourself whether that's expensive by comparing it with other biotechs with similar growth trajectories, or you can think back to what NYU professor Aswath Damodaran told us on this podcast a couple of weeks ago: that true valuation work requires calculating a present value to pay for the sum of a company's cash flows far into the future. That's more complicated and time-consuming, but if you're thinking about making a big investment, you might want to learn how to do it. Check out one of Aswath's textbooks on valuation, or just look at the free course material on his website. 3 things to keep in mind: first, drugs have patents, and those can greatly affect your analysis. You have to watch out for what's called a patent cliff—when a company loses exclusivity on a key drug. When that happens, competing drugs can enter the market, driving prices and profits down. If shares of a mature drug maker seem exceptionally cheap, it might be because there's a patent cliff coming soon. Then you have to decide whether the shares are cheap enough to make up for it or whether management has a good enough plan or pipeline of drugs in development to make up for the cliff. Patent analysis should be straightforward. In the U.S., drug patents generally last for 20 years from the date of filing. But in reality, there's something I call the patent dance, which makes patent analysis diabolically difficult. Companies can easily extend patents to make up for the time spent seeking regulatory approval. They can also use more creative means. For example, they can take out new patents on drug delivery systems or combinations or manufacturing tactics and use those to try to extend their sales exclusivity. The second thing to keep in mind is that it's not uncommon for even mature drug companies to depend heavily on one drugs for their revenues. For example, until last year, AbbVie got nearly 60% of its revenue from a rheumatoid arthritis drug called Humira. That kind of concentration adds risk. The easiest fix for it is for a company to buy something big or be bought by something big. Last year, AbbVie bought Allergan, whose products include Botox, and now Humira is down to around 43% of total company revenue. The last thing to keep in mind, or, is that if you want to use your particular expertise in biotech drug development to find promising stocks, you might want to focus on early-stage companies with drugs in development but with little or no revenue today. They tend to be less closely watched on Wall Street. To evaluate those companies, start by determining the size of their potential market. Think of the disease or diseases a company is trying to treat and the size of the patient population and how many patients might take the drug based on the availability of competing drugs, then estimate pricing, margins, and cash flows far into the future, then determine the company's probability of success. Companies like this are incredibly risky. Sometimes Wall Street analysts think of the shares as long-term options contracts where you get a binary outcome: a big payoff or none at all. Who do we have next, Mena?

Our next question is from Brendan, who at the time we received this question had been living in Austin, Texas for 3 weeks after having moved from New York City. Hmm.

To answer your anticipated question with a question, why pay $4K a month for a terrible apartment in shutdown New York when I can pay $2K for a great one with a pool and can work remotely? Did I mention no state income taxes?

Okay, the pool sounds nice. Go on, Brendan.

Anyway, to get to the point, I invested heavily in solar stocks a couple of years ago and the returns have been spectacular, especially after the merger of Sunrun and Vivint recently. Do you believe this growing industry is just getting started from a market value perspective, or are investors too optimistic? Thanks.

Love the show. Thank you, Brendan. 2 years ago, for a cover story for Barron's, I visited a Massachusetts town of 8,000 people called Sterling. Now Sterling had an 8-acre corn maze out by Davis Farmland, but that wasn't why I went. And it had a statue of a lamb in the middle of town right near the corner of Main and Park. The townspeople say that lamb followed a local schoolgirl named Mary Sawyer to school one day in 1812 and became the inspiration for the nursery rhyme "Mary Had a Little Lamb." But I wasn't there for lambs either. I went to Sterling because it's not uncommon for Massachusetts towns to own their own power companies, and Sterling had invested in solar power. But just as important, in 2016 it had placed a single shipping container at the power substation out on Chalksett Road, and inside that container were rows of lithium-ion batteries. Those are the same kind used in electric cars and laptop computers, only here they use special software for regulating power distribution. That battery array happened to make tiny Sterling America's per capita leader at the time in storage for solar power. And it's one of the reasons I'm quite bullish on the solar power industry. The cost of generating power from sunshine has already plunged to the point where it's competitive with fossil fuels, but of course, the sun only shines during the day. Battery storage solves this problem and brings other benefits, like smoothing out peaks in demand. And the power industry doesn't have to start from scratch on battery development. It benefits from the research being done by the car industry. The COVID-19 pandemic has set back solar installations this year, but over the next decade, battery capacity for solar power is expected to multiply many times in size from a small base. It's one of the reasons I think solar power will continue gaining share from fossil fuels. Not all solar companies will benefit equally, of course. The industry is complicated. Solar companies are basically semiconductor companies, just like computer chip makers, except the computer chips don't have to be professionally installed on rooftops and earn back their cost of installation over years. Solar stock returns can be volatile, so you might want to buy a basket of them rather than just one. For example, there's an exchange-traded fund that tracks a group of solar stocks called Invesco Solar, The ticker there is T-A-N, TAN. That fund has returned about 140% since that solar cover story I did a couple of years ago. But be aware, that includes a price spike of nearly 80% this year. Now, as to moving to Austin from New York City, Brendan, I wish you the best of luck. New York City is a great place to start your career, but as you say, your money can go a lot further in other markets. There's a debate going on right now that's different from the economic points you make, Brendan. It's about whether New York City has entered a state of permanent decline. There was an opinion piece arguing that recently in the New York Post, written by a guy who owned a comedy club. By now you've probably seen the opinion piece, New York City is Dead Forever, written by a now former New Yorker who fled to Miami by choice. Then comedian Jerry Seinfeld published a rebuttal in the New York Times. And the title of what he wrote is, "So You Think New York Is Dead," and then right below it says, "It's Not." I'll just say that I spent more than 2 decades of my life in New York City and more than a decade in what at the time was a tiny town in upstate New York, the kind where class attendance dropped noticeably on the first day of deer hunting season. Now I live about halfway between those 2 places. Think of me as a liaison between big city America and small town America, and I can assure you they both have many virtues. I just can't jump on the bandwagon of New York detractors. This state has 1% of the country's land mass and 8% of its gross domestic product. In other words, it's hard to root for America's success without hoping its biggest cities thrive. But Brendan, I'm definitely jealous of that pool. I hear you can't get one of those installed right now for any amount of money. For my kids, I have a giant inflatable bouncy castle with water cannons and slides, but I'm a few pounds over the weight limit. By a few here, I mean about 185. And by 185, I mean 200. Meta, I know I'm rambling on for too long with the answers to these questions. I think it's the microphone. Do you have any questions that I can answer quickly?

I think so, and it's on a very important subject. It's from someone called Tom.

Great, roll it. Jack, do you believe a hot dog is a sandwich? Hello, Tom.

You've come to the right place to solve this matter once and for all. Now, a hot dog is meat on bread, just like a ham and cheese sandwich, which suggests that a hot dog is in fact a sandwich. But a Reuben is also a sandwich. If I asked you for a Reuben sandwich, that might sound redundant, but you'd know what I was talking about. However, if I asked you for a hot dog sandwich, you'd think either that I was an extraterrestrial posing as a human, or that what I really wanted was two hot dogs cut in half lengthwise and arranged between two slices of sandwich bread. And that suggests that a hot dog sandwich is different from a hot dog, which strongly implies that a hot dog is not a sandwich. I think in the end analysis, what we have to do here is think in terms of bun equivalence. Now, a sandwich is differentiated from other foods by the bread. There are many types of sandwich breads, from hero rolls to sliced pumpernickel. A hot dog gets its own type of bread called a hot dog bun. So is a hot dog bun a sandwich bread? It is if we can think of something that is indisputably a sandwich and that can be made using a hot dog bun. And that something, Tom, is a lobster roll. A lobster roll is a sandwich. I hold that truth to be self-evident. And that makes a hot dog a sandwich too. I'm not happy about the answer. It feels wrong. But I have to go where the bond-equivalence math is leading me. Meta, we're covering a lot of important ground now. Who's up?

Yeah, our next question is from Brett from Huntsville, Alabama.

Hi, Jack and Meta. Big fan of the podcast. I listen to it every week, usually when I mow the lawn.

So Brett wants to know about retail REITs, and he mentions a couple of concrete stocks. They have the tickers FRT and NNN.

I've noticed that REITs and retail REITs have very much dropped significantly, understandably, since the coronavirus pandemic. And FRT and NNN in particular have a history of a very high dividend. Now, I was just wondering if you feel like they're undervalued and a good buy, or what you think their prospects are in the near and long term. Appreciate it. Thanks.

Thank you, Brett. I'll try to say this loudly and clearly so you can hear me over the mower. REITs are real estate investment trusts, and they provide a way to invest in a portfolio of real estate like you would a stock. Much of retail has been hit hard by the pandemic, and investors expect that pain to be felt by landlords, so retail REITs have sold off. Brett, I think you mentioned FRT. That's Federal Realty Investment Trust. It has a 5.3% dividend yield. At a glance, I think that's a large enough yield to tell you that investors are down on the group, but not so large to suggest that investors expect an imminent dividend cut. Of course, to be more certain about that, you want to compare dividend payments with profits, which for REITs are tracked using a measure called Funds from Operations. One thing to know about retail REITs is that the group was under stress before the pandemic. In its annual report for last year, Federal Realty mentioned store closures from chains like Dressbarn and Payless ShoeSource as cutting into its rent growth. The retail reckoning is a complicated subject that we discussed in an earlier episode of this podcast. Suffice to say that online shopping has played a role So is the death of enclosed malls and B or C markets. But mostly, America simply has far too much retail square footage compared with the size of its population. I believe that it was headed for a decade of accelerated store closures even before the pandemic. The good news is that management at Federal Realty has had time to try to build the portfolio around things that are working, like shopping centers that open to the outdoors in economically strong markets and mixed-use spaces that include, say, workspace for a big tech company combined with shopping space. Shares of Federal Realty are down about 35% so far this year, so the market has already reacted to the effects of the pandemic. Evercore ISI, an investment bank that was bearish on Federal Realty, upgraded it to a neutral view in mid-August, writing in a note to investors that it thinks funds from operations bottomed in the second quarter and will recover from here. Brett, you can make up your own mind on this particular REIT, but the answer to your question is yes, I think there are opportunities in REITs, even retail REITs, worth considering. Look for ones that are well-capitalized with favorable exposure and attractive valuations. And think of what we've seen so far in 2020 as a stress test that should give you valuable information. Should we do one more quick one, Meta?

I think we should, but it'll be the last one.

OK, let's hear it. Hi, Jack.

Hi, Metta. My name is Will, and I'm calling from St. Paul, Minnesota. At 27 years old, I'm a young investor, and I've started planning for my financial future by studying Warren Buffett's approach to purchasing businesses. I know that when Buffett started out, he methodically picked through the entirety of Moody's investment manuals to quickly identify businesses that might be of interest to him. I've done the same with the Value Line Investment Survey, which is freely available through my local library. I'd like to find a similar resource that allows me to quickly view 10 years or so of financial history for companies with a smaller market cap. My question to you is, what's the best parallel to Moody's manuals or to Value Line Investment Survey that's available to investors on a budget? Thanks.

Thank you, Will. Your question takes me back to the early 1990s when I was a stockbroker. We had computers for stock quotes, but we didn't have the internet. Some trading was still done by filling out a ticket and handing it to a clerk who timestamped it. If a client wanted to talk about a stock, the broker could walk over to a shelf of big binders and find what was called a tear sheet, a page with information about the company which was updated by mail each quarter. That's the kind of setting that made investment manuals useful. Today, of course, all that information is available online, with company financials updated as they're reported and price data updated in real time. You mentioned ValueLine, Will. That's an investment service that combines company information with analyst opinions on which stocks are attractive. It's available online for a subscription. I don't use the service and I don't have an opinion on it. The alternative is to screen for stocks yourself. Now, screening doesn't tell you which stocks to buy. It just reduces an unmanageably large universe of stocks to a handful for further research. You can do that by searching for clues that tend to predict promising price returns, and the best way to identify those clues is to keep up with academic research that tests the efficacy of different clues. For example, if you're confident that recent price momentum is a good sign, you can search for it. If you think low share prices relative to free cash flow are the thing to favor, you can screen for those. You can combine clues and build your own screens, You can favor one screen recipe or several. I primarily use two stock screeners, one from Bloomberg and another from a company called FactSet. They're fairly expensive. In my case, someone else pays the bill. The good news for you is that many online low-cost brokers throw in stock screening software for free to give their account holders a way to find new investment ideas. The library is a good start, Will, but my advice to you is With cheap or even free stock trading so widely available, shop for the broker that has the best stock screening software and then search for your own stocks for free. Thank you to everyone who submitted a question for this episode, and please keep the questions coming. Just tape on your phone, use the voice memo app, and send an email to jack.hough, that's H-O-U-G-H, @barons.com. Thank you for listening. Meta Lutzow is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you listen on Apple, write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @jackhowh. See you next week.

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