3 Reasons Buffett Hates Biotech

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I haven't ever heard him say it directly, but it's pretty clear that Warren Buffett has no interest in buying biotech companies. I don't know of any small drug company that Berkshire Hathaway  (NYSE: BRK-A  ) (NYSE: BRK-B  ) has ever invested in.

It's not that he avoids the health-care industry altogether. Berkshire owns shares of big pharmas: Johnson & Johnson (NYSE: JNJ  ) , Sanofi, and GlaxoSmithKline (NYSE: GSK  ) . And it owns shares of DaVita, which runs dialysis centers.

But despite the potential monster returns, the Oracle of Omaha has avoided buying smaller biotechs. Here are a few quotes that might explain why.

"Never invest in a business you can't understand."
Buffett has admitted to not following the pipelines of the pharmaceutical companies he owns. That's OK for larger companies, where the growth of the drugs currently on the market has a large influence on the valuation. One pipeline success or failure isn't going to make or break Johnson & Johnson, with $67 billion in annual revenue, or Glaxo, with $40 billion. Adding a $1 billion blockbuster will increase revenue by less than 5%. Smaller drugs affect the top and bottom lines by even less.

Biotechs, on the other hand, live and die by their pipeline. Whether it's their first, second, or even third drug, the additional revenue is huge. If you're going to invest in biotechs, it's critical to understand the drugs in the pipeline, where they're at, their likelihood of success, potential sales, competition from other drugs on the market and in other companies' pipelines -- and the list goes on.

If Buffett doesn't want to put in the time to understand the nuances of the sector, I think he's right to stay away.

"Our favorite holding period is forever."
Even if Buffett wanted to put in the effort to learn the science -- and he's a smart guy, so I'm sure he could figure it out -- this Buffettism would make it difficult for him to make a purchase. A vast majority of biotechs swing from way undervalued to way overvalued, often over a very short time frame -- think months -- certainly not forever.

And there's a big difference between a development-stage biotech and a commercial-stage biotech; A company that might be great at developing drugs isn't necessarily one that can sell them well. Dendreon (NASDAQOTH: DNDNQ  ) is a perfect example. Many investors thought its prostate cancer treatment Provenge wouldn't work. The FDA rejected it, asking for more data. The second trial proved that Provenge extended patients' lives, and shares shot up from under $3 to over $50 on FDA approval. Now, three years later, the company sits under $5, paralyzed by sales that didn't live up to expectations.

Unlike Coca-Cola or Heinz -- two Buffett-owned companies -- it can be hard to predict patient adoption and physician prescription numbers especially years before the drug is on the market.

The best way to profit in biotechs is to jump in when investors are ignoring the stock and jump out when they've overreacted. That's value investing, but it's not Buffett's idea of investing.

"We have got an elephant gun, and it's loaded."
Biotechs are far from elephants. Think squirrel or opossum.

A typical clinical-stage drugmaker is valued under $1 billion. Berkshire Hathaway invested $26 billion in Burlington Northern plus $10 billion in debt for the remaining part of the $44 billion company he didn't already own. Buffett invested about $13 billion in cash to get a large chunk of Heinz.

It takes a lot to move the needle at Berkshire. A little biotech isn't going to do it.

Ignore Buffett?
I hope they don't take away my jester cap for saying this, but I think it's OK not to follow Buffett. Biotech is clearly not for him, but I've never actually heard him say it's a bad idea for me and you.

In fact, all three reasons I've cited for why Buffett wouldn't want to buy biotechs are easily overcome by most investors: Learn about the industry, be willing to sell when companies become overvalued or the thesis changes, and don't become a billionaire.

And while I disagree with Buffett's possible reasons for not liking biotech, it's hard to argue with his thoughts about "the tapeworm that's eating at American competitiveness." Find out what Buffett was referring to in our free report: "What's Really Eating at America's Competitiveness." You'll also discover an idea to profit as companies work to eradicate this efficiency-sucking tapeworm. Just click here for free, immediate access.

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  • Report this Comment On March 31, 2013, at 10:26 PM, gistanleyjr wrote:

    1. He doesn't understand science.

    2. He doesn't have a BS & MS in microbiology.

    3. He is too lazy to understand science.

    How's that to start? Also, too many cherry Cokes and too many cheeseburgers, his favorite foods.

  • Report this Comment On March 31, 2013, at 10:56 PM, SaraW946 wrote:

    It is certainly ok not to follow Buffett, but I would really not invest in Biotech companies because I see investing as a calculated risk and not gambling. In the past, I invested in those 3-D companies that were strongly recommended by Motley Fool. My conclusion: too volatile and frankly, all those excited get rich quick ideas a really not my thing, nor are they a good idea. I did watch a few videos about the applications of 3-D printing technology, say in creating artificial kidneys for transplants. Impressive but impossible to really use at the moment. You know what I did? I decide to understand the product profoundly and the easiest way was asking every doctor I knew. I obviously did not ask whether I should invest, but rather whether they could use the technology for specific things, for example my knee. Not only did they tell me everything about the technology and its possibilities, they also explained to me the whole research. Their verdict was that is was not going to happen yet.

    I sold the 3-D printing shares I had and decided that humans will unfortunately have to use conventional treatments for longer than I thought. Plus the technology was not at all certain to prevail. Dialysis was still the way to go and so I bought Davita. To my great amusement I saw at Buffett had the same idea. Guess what: I made more money and more steadily than I did wi the 3-D very questionable investment. In all likelihood, I will continue to do so.

    Yes, I know, maybe, perhaps, potentially, some people may speculate and make money. Great, and I sincerely wish them all the best. However, I will continue to invest as I do because this has made me a lot more money.

    Finally, I think it's a gross mistake to think that when Buffett says he doesn't understand how a tech company works, he doesn't understand how a computer works (for example). I'm always amazed when people misunderstand and misquote him. As for all those bloggers who write all those "Where Buffett Got It Wrong" and their readers, they should rather consider that he is a lot more successful than all of them put together and that's not a coincidence. The bottom line here is to make money, right?

  • Report this Comment On April 05, 2013, at 1:20 PM, TMFDarwood11 wrote:


    Great comments.

    I think that what I take away from WB is simply this "Know your limitations."

    Mr. Buffett invests in things he understands, and in business models that means buying into what in his view has possibilities. Certainly there are others. Yet, as noted, he also has the constraint of deploying cash in a way to make a meaningful contribution to the bottom line.

    I learned that the hard way a few years ago when I realized that my new cash deployments were doing well but were too small to make a meaningful contribution to my bottom line. I adjusted, re-evaluated each purchase and increased it.

    I do have a criticism of some articles about WB and it is that many fail to realize the wonderful advantages of "clout." For example the great deal he got via GE preferred shares a few years ago. I would have loved to have access to that in 2008/9. But we mere mortals don't have this sort of access.

    However, Mr. Buffett is in some ways a tortoise. He avoids the flash, yet takes advantage of opportunities when they arise. Many Motley Fool readers did the same and got on board in 2008-9, did the unthinkable and bought stocks during "the panic." Some did so by simply by staying the course and continuing those monthly retirement fund purchases via dollar cost averaging.

    It's my opinion that Mr. Buffett executes, and does so well.

    We should all follow that example.

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