Intelligent Investments: Health Care Glut

Monday, November 13, 2006

Health Care Glut

Today I am selling out of one of the sector funds I currently own. The Fidelity Select Health Care has returned just 10% over the last 18 months and with the Democratic sweep of congress, I think HealthCare will only tread water at best.

Pharmas are going to be the main whipping post for the democrate in congress but with just a slim majority and President Bush still in the White House with his veto power, little action will be taken. Right now, Pharmas have experienced a downturn since last Tuesday. Wall St. is basically pricing in a slim chance of some pricing controls being passed. For now, the sectors outlook looks as bright as ever.

My position in Genentech will not be altered. At $81 a share, it is trading at 30x forward earnings; not cheap by any means but way off hisotorical P/e's. This might present a possible buying opportunity for additional shares for a company growing at a 20% rate.

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Buffett's Value Formula (?)

Warren Buffett hasn't exactly published his formula for what he calls the intrinsic value of a company, but he has dropped a number of hints. He apparently multiplies estimated future earnings by a confidence margin between zero and a hundred percent (a bird in the bush being worth 0.5 birds in the hand, and all that; bush birds are the earnings you hope for, and hand birds are the earnings you're confident will materialize). He then compares these probable earnings with something he has total confidence in, by using a U.S. treasury yield as his discount rate. In calculator form it looks like this:

This calculator doesn't use fancier math than the original one did. Its advantage is that it forces you to be explicit about your earnings expectations. It also automatically provides you with a hard-headed investment strategy: always invest in government bonds, unless you can find something else you are confident will yield more cash.

One other hint that Buffett has dropped over the years is that he can estimate value in his head in about five seconds; so whatever he does he keeps it simple, slugger.