Kristine Harjes: Why thinking like a scientist
can make you a better investor on this healthcare
episode of Industry Focus.
It is April 19th, welcome to Healthcare Industry Focus!
I'm your host, Kristine Harjes, and
I've got Todd Campbell on the line. Todd,
how's it going?
Todd Campbell: It's going very well. Glad
to be here.
Harjes: Good, glad to have you as always.
Gaby Lapera and John Maxfield did a show on
Industry Focus last Monday, April 11th about
writing and how learning to be a good writer
helps you with your investing. We got a lot
of really great feedback about that episode.
It is a great one, so make sure to give it
a listen if you haven't already.
I have to say I have always been more of a
math nerd than an English nerd. I had this
idea. Fortunately, Todd was onboard with me
here. We want to make the argument for thinking
like a scientist in your investing and how
it can help you make better financial decisions.
We'll start out by talking a little bit about
the overlap between science and investing.
Then we'll do some more healthcare specific
stuff. Sound like a plan, Todd?
Campbell: I think that's a great way to approach
it. Listeners, don't get too nervous here.
You're not going to need to be a scientist
to be able to invest in healthcare. We're
just going to walk you through some thoughts,
things that we think that could help you in
your process.
Harjes: Yeah, this is definitely more of a
high-level episode as opposed to, "Well, if
you're looking at this clinical trial data
and you see a p-value that doesn't correlate
with you ...." We're not going to bog you
down with that, so, no worries.
Todd, when we were chatting earlier, you mentioned
Adam Grant, who, I was really excited when
I saw your note about him because I actually
just read his book, Originals. He has a lot
of really great thoughts about thinking like
a scientist and how to best use a really empirical
framework in making decisions. Did you want
to talk a little bit on him?
Campbell: Yeah, he was just at Motley Fool
HQ wasn't he?
Harjes: Yeah, he gave a really, really fascinating
talk.
Campbell: Yeah, what struck me about him,
or what reminded me was we were doing the
work leading up to this episode. I was listening
to the podcast that he had recorded when he
was there. It was a fascinating discussion,
because it talked a lot about how we come
to make our decisions.
Harjes: Yeah, we get emotional, as humans,
about a lot of things and we know, in investing,
that time and time again individual investors
often lose to the broader market because they
let their emotions get tied up in their decision
making. As Adam Grant points out, trusting
your gut only really works when you're an
expert working in your field of expertise.
Outside of that, you're better off following
more of a structured, methodical way of thinking.
Campbell: Right, it's all about process. If
you have a process that's repeatable, something
that you can put into place and continually
refer back to and then use time and time again,
eventually maybe you'll get that experience
level where you can rely on your gut, but
yeah, investing with your gut, especially
in healthcare where there's a lot of nuances,
especially in biopharma, yeah, it's good to
have a process that you can spell out and
walk your way through.
Harjes: Right, so that process, of course,
and we're talking about science, is the scientific
method. It's just a very elementary concept.
I think I probably learned it first in elementary
school, but it is so robust and so useful
that it's something I still use to this day
in my investing and outside of that.
I'll just start walking us through what this
scientific method is. There are some very
clear steps to it. Then, maybe we can talk
about how it relates, particularly, to investing.
First things first. When you're looking at
the scientific method, you need to ask a question.
If you are an observant person, which hopefully
you are, you're going to be picking up new
ideas all the time, learning things from the
world around you and you're going to hear
these ideas about new industries, and new
companies. Maybe you see something in the
news, or on a podcast and as an investor,
you're asking, "Is this a good place for my
money?" There's your question, "Do I want
to invest in X?"
Campbell: Right, and you know the other thing
to add to that, too, Kristine, is if you can
be more specific when you're asking your question,
even better.
Harjes: That's a great point.
Campbell: Asking the question, "Is Celgene
likely to go higher?" Maybe you're not going
to be able to narrow that down quite as easily
as maybe if you could say, "Will Otezla, their
autoimmune disease drug, see their sales grow
over the course of the next 52 weeks?"
Harjes: Once you have that question in mind
and I really like your commentary there that
the more specific, the better, you need to
do some research. You need to understand what
are some of the competitors in this space,
or what is the industry all about to begin
with? You want to make sure that you have
that solid understanding before you get to
your next step, which is to construct a hypothesis.
This is absolutely the essential point in
the scientific method. If you remember one
step out of this, remember to construct a
hypothesis.
Campbell: It's like trying to figure out where
you're going without a map.
Harjes: Exactly, yeah, and this actually really
ties back into what Gaby and John were talking
about on Monday, because you should write
it down. You should have a solid thesis statement
hypothesis and write it down and be able to
carry it with you as you go through the rest
of the scientific method.
Next step, in the official scientific method,
is to test your hypothesis via an experiment.
The way that I would think about that for
us, for investors, is that people running
these companies are running experiments. You're
running a business. You don't quite know what
the outcome is going to be, but you're putting
in all these variables and you're testing
things.
Even though it's not you, the investor, necessarily
conducting this experiment, it is still your
job to keep an eye on the company leadership
and what exactly they're doing so that you
can hit ....
Campbell: There are other ways to, not as
deep diving as that, but if you have a hypothesis,
you think the stock may be going up because
of a certain drug and the sales may be increasing,
then track the sales of that drug. See whether
or not they truly are increasing quarter after
quarter, after quarter. Put the stock on a
watch list if you haven't invested in it yet.
See whether or not the stock is acting well,
if it's trading up on greater volume, if people
are embracing the story.
Harjes: Exactly. Yeah, that brings us right
to the next step, which is to analyze this
data. Say you can find data about new prescription
volumes of this drug that you're interested
in, and you want to correlate that to the
stock price, you can do that. You can make
a regression and try to draw a conclusion
from it.
Once you have that conclusion, the very last
step in the method is to communicate your
results. We're so fortunate to be part of
this Motley Fool community where there are
other people that are really, really interested
in talking about this kind of stuff. You can
go to Motley Fool Caps. You can go to our
boards. There's this whole community of people
out there that want to review your work. They
want to look at your hypothesis and your research
and see if your analysis is correct.
Campbell: What's great about that too, is
it provides ... You and I talked about this
previously, but you have to be a little bit
nervous when you're an investor about confirmation
bias. You come up with a conclusion; you've
determined what you think will happen. From
then on out, you run the risk of excluding
any kind of information that may call that
into question and just simply reinforcing
that same conclusion over and over again with
what you read.
By opening yourself up to a broader community,
you're challenging that. You're allowing people
to be able to say, "No, I disagree with you.
Maybe you didn't think of this."
Harjes: Yeah, I think that really gets at
the most important part of thinking like a
scientist in this entire thing, which is that
when you're presented with new evidence, you
need to be able to look at it critically.
You got to take your emotions out of it, even
if you have to admit that you were initially
wrong in light of this new fact, or this new
piece of information. That happens. You don't
want to be overrun by this confirmation bias
as you mentioned. You need to be able to take
in new evidence and say, "Okay, is my hypothesis
still correct?"
Campbell: That's one of the biggest, most
difficult and most challenging things facing
investors. It's very hard when you've invested
your time, your effort, and your money into
a certain idea to say, "You know what? I was
wrong."
Harjes: It is extremely hard. Hopefully I
help you guys see a little bit more how this
works with some specific applications and
particularly in the healthcare field, we're
going to dive into a couple of examples.
First, I want to point our listeners to podcasts.fool.com
where you can explore the entire suite of
Motley Fool podcasts. Did you know that we
have 5 different ones? In fact, Chris Hill's
Market Foolery is having its 1,000th episode
tomorrow, which is very, very exciting. It's
going to be a great show. Definitely check
that out and also check out podcasts.fool.com
to see what other podcasts we have to offer.
As promised, we are going to take some of
this framework of thinking like a scientist
and apply it to healthcare stocks. Where should
we begin?
Campbell: We have a few different topics there
probably fresh on the minds of listeners here.
We can start with Illumina if you like.
Harjes: Yeah, we talked about Illumina last
week on the show.
Campbell: We sure did. We talked about the
future of healthcare. We discussed how gene
sequencing and the use of gene sequencing
could revolutionize the innovation of personalized
medicine.
Harjes: If you had listened to our podcast
last week and bought shares of Illumina after,
of course, doing your own research on top
of ours, you might have had a pretty strong
emotional reaction to the news on Monday night
of Illumina releasing their preliminary financial
results, which ended up causing the stock
to shed over 20% of its value on Tuesday.
Campbell: It was a big drop. Basically, their
sales in the first quarter are lighter than
what industry watchers were hoping for. They
thought that sales would continue to grow
by a higher percentage than they're actually
going to grow. As a result, people got very
nervous and the knee jerk reaction was to
press the sell button.
Harjes: When we were looking at Illumina,
to go back to our scientific method, what
is the hypothesis there? If you were an Illumina
shareholder how would you have communicated
the buy thesis?
Campbell: I think that the reason to own a
company like Illumina and, spoiler alert,
that reason hasn't changed just because of
what we found out on Monday. I think that
what we're trying to communicate here is,
where is medicine heading?
Is medicine getting more and more specific
to the genetic makeup of everyone that's suffering
from disease, be it cancer, or be it some
sort of a rare disease, an orphan disease?
The use of gene sequencing is going to allow
us to transition from these small molecule
drugs that just treats a whole lot of stuff
and hopefully treats what's ailing you too,
to these very specialized medications.
Harjes: Illumina is, by far, the leader in
this space. If that's your buy thesis, and
you look at these results and you say, "Oh
well, it looks like Europe was a little bit
weak." which, by the way, even with your having
a little bit of weakness, we're still seeing
double digit growth projections for this company.
It seems like that doesn't really modify the
thesis.
Campbell: No, it doesn't. There's a few things
that we have to do. You have to do your background.
You look at it and you say, "Okay. They're
saying that Europe was slower than the rest
of the world." You've got Asia and the United
States growing at mid-teens growth rates.
You've got Europe growing at what they think
is going to be low to mid-single digit growth
rates. Growth, not a retrenchment, a growth
still, but slower growth than the rest of
the world.
Then you ask yourself, "Well, why is that?
What are the things that could be going into
the reasoning behind Europe growing more slowly
than the other parts of the world?" Once you've
asked that question, then you can start to
seek out the answer if you will.
Harjes: I think if you dig in and one of the
things that you find is that it was competitive
threat-related, which, to me, it doesn't seem
like that was, but I do think that in my own
personal thesis on this company, I'm not a
shareholder, but if I were, That's a huge
element to the thesis. Is this company going
to remain the dominant player?
Campbell: Surely, you've got a lot of companies
out there who are trying to get involved in
this space before, theoretically, it blows
up and gets a lot bigger. You've got Thermo
Fisher, which bought a company called Life
Technologies a few years ago. They do a lot
of work in the clinical space, in basically
developing systems that can be used for targeted
gene sequencing. You've got an upstart out
of the UK called Oxford Nanopore. It's a brand
new approach to gene sequencing. They actually
market a handheld gene sequencing device and
have plans for a much larger device that could
theoretically compete some day with Illumina.
Yeah, there are competitors out there in the
marketplace that we have to be aware of. If
you look at the reasons and they didn't go
into a lot of depth, but if you listen to
the conference call and you listen to the
reasons, one of the things that they said
as far as why Europe is slowing is because
of sharing of devices.
Maybe in Europe, you get more research teams
sharing the devices than maybe you would get
in other markets like the United States. That's
not new. It's hard for me to understand why
they didn't model for that appropriately.
You still do have to consider the competitive
aspect here. It's obvious that that, from
their perspective, is having an impact.
Harjes: It'll definitely be something to look
out for in May when they release their official
results; listening in on that conference call
and gather more evidence to test against the
original hypothesis.
Let's take one more example. This is something
that is even more recent than the Illumina
news. United Health Group announced that it
was going to leave the Obamacare exchanges
all but entirely. What does this mean?
Campbell: Yeah, it's not a complete and utter
surprise because they communicated that they
were going to have discussions surrounding
exiting Obamacare.
Harjes: They're anticipating a billion dollars
of losses between 2015 and 2016 because of
these exchanges.
Campbell: Yeah, they lost, I think it was
over $400 million last year. They came into
the year thinking they were going to lose
$500 million this year. Then in their conference
call last night, they said, "We think we may
lose $650 million." It may not sound like
a lot when you're talking about a company
with $44 billion in revenue, but this is a
very low margin industry. If you look at their
premium revenue of 34 or $36 billion, their
earnings from operations on that business
was only, I think, $1.6 billion or something
like that, very thin margin business. $650
million, I can understand why they want to
rein in their exposure to that.
Harjes: If you're somebody that's interested
as an investor in United, does this change
your thesis? Is Obamacare ....
Campbell: I don't think so. Do you?
Harjes: Is Obamacare even a big enough ...
Campbell: Do you think the people aren't going
to buy that stock now because of Obamacare?
Harjes: No, I actually think it's a good thing.
You're exiting something that was clearly
not profitable for you. That's the example
of the scientific method right there, is saying,
"You know what? We tried this and it didn't
work."
Campbell: Keep yourself open to opportunity.
Other competitors in the space, they're not
coming to the same conclusion "Yet". We don't
know if they will eventually come to that
same conclusion. Obamacare exchanges are expensive
because you've got people who weren't previously
insured. They're now starting to go out and
get care. That care is expensive. If you don't
model for that correctly and you don't price
your premiums correctly in the marketplace,
you're going to lose money.
It's going to be very interesting to see how
this plays out. I think that from a shorter
term perspective this is the right move for
shareholders because it allows United Healthcare
to retrench, reevaluate, and then slowly,
but surely begin to increase their exposure.
You have to remember, too, that this company,
they went from operating in just four states
the first year, so three years ago, to 34
states last year. They expanded this extremely
rapidly. It's hard for me to understand how
they scaled it up this quickly without expecting
there to be some problems.
Harjes: That's a good point too. It was a
quick ramp-up and it looks like a pretty quick
ramp-down, too. I actually do perceive that
as a good thing where the company can look
at its decisions and say, "Okay, realistically,
maybe that wasn't so smart. Let's backtrack
a little bit here."
Campbell: There are going to be parts of the
country that are going to be more profitable
for insurers, based on how they design their
patient pools. I think that once UNH digests
all the information it's got now, it's going
to have a much better chance of figuring out
where those parts of the market are most profitable
for it to participate, and those are the ones
it'll stay in. As we go forward, maybe they'll
start to fold in other areas in the coming
years. Yeah, I think it's smart to retrench,
think about where you're going and then roll
it out from there.
Harjes: Exactly. We got lucky here doing this
episode this week that we had two really good
examples come though the news for us.
Campbell: Yeah, it didn't take us long to
figure out what to talk about today did it?
Harjes: Exactly. Thank you, Todd so much for
your excellent analysis, as always, and for
your time. Folks, thanks for listening. One
housekeeping note before we totally sign off.
I have been instructed to mention that the
Thursday and the Friday shows of Industry
Focus are going to be swapped this week. You'll
see the tech show coming through on Thursday
and the energy show on Friday. Huge shake
up, I know, catastrophic. If you want to complain
about it, or maybe celebrate it, I don't know.
You can email us at industryfocus@fool.com.
Thanks for listening, folks!
As always, people on the program may have
interest in the stocks that they talk about
and The Motley Fool may have formal recommendations
for or against these stocks, so don't buy
or sell based solely on what you hear.
