If you're investing and you've ever asked yourself:

  • What does it mean when a stock is moving for seemingly no reason?
  • How can emotion influence investing and lead to bad decisions?
  • Why do investors need an investment thesis?
  • How should investors approach an industry with multiple companies competing in the same marketplace?
  • Is it okay to buy "expensive" stocks?

Then, do we have a show for you!

In this episode of The Motley Fool's Industry Focus: Healthcare, departing analyst Kristine Harjes discusses with Todd Campbell the lessons she's learned while hosting The Fool's Healthcare podcast. In this show, the two share their biggest investing gaffes, and importantly, how to avoid making the same mistakes yourself.

A full transcript follows the video.

This video was recorded on Sept. 12, 2018.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Wednesday, September 12th. I'm your host, Kristine Harjes, and I'm joined via Skype by healthcare specialist Todd Campbell for my last show before I move on to my new role with Motley Fool Ventures. Todd, how are you?

Todd Campbell: I'm doing great! Are you ready to drop some investing truth bombs in this swan song? 

Harjes: Yes, I so am! Todd and I were thinking that for this episode, we would do a bit of a look back on what I've learned over the last three and a half or so years of hosting this show. I'll be honest with you guys, I knew close to nothing when I started. I'm sure the healthcare industry could keep teaching me things for the rest of my life. But, I also feel like I've learned a lot. I thought it would be valuable to share some of these lessons. 

Todd, really, I have you to thank! I have learned so much from you on how to approach stocks and industry trends. I think today will be a really good informal conversation anchored on some of the key lessons that we wanted to highlight.

Campbell: Aw, thanks! It's been my pleasure! One of the things I think our investors probably recognize from listening to the podcast, we try to keep it real. We try to explain things in a way that people can understand relatively easily, and share both our failures and our successes. If you don't do that, you can't learn. And if you don't learn, then how are you going to get better? 

Harjes: Exactly. You're not going to be right all the time. But we think it's important that you learn from those times when you were wrong, and also, as your process evolves, that you take note of these little tiny adjustments that you can do to make better investing decisions, better life decisions, all of the decisions. 

Let's get started on the surface level with show prep. I don't know about you, Todd, but the way that I prepare for these shows has changed a ton. It goes directly back to becoming more efficient in researching stocks and healthcare news. Since I started doing the show, I've subscribed to daily emails from sources like STAT News and Endpoints, Axios, Vitals. And I'll read these with an eye toward what would make for good show content. It's also just a good way to keep tabs on what's going on, what's making big news, and also, what are some upcoming catalysts.

Campbell: I agree with you. One of the things that's changed dramatically for me in the last three years -- and some people may laugh at me, but trust me, there's actually some really good content available -- is Twitter. 

I participate way more in Twitter than I did three years ago. I use it as basically a filter, a funnel for ideas. I follow a bunch of people that I respect within the healthcare industry. As a result, as I go through Twitter once or twice a day, I'll usually see something that will make me go, "Wow! I hadn't thought of that!" or, "Boy, that's something I should look at a little bit more!"

Harjes: I totally agree! I am pretty social media wary. I'm on most of the major platforms, but I don't really use them. But Twitter, for me, has this very specific use case that's entirely related to my job. If a stock pops or drops, and I don't really know why -- I went to the ticker page and I read all of the recent news, there's no press release -- I go to Twitter. I search for the ticker, with the dollar sign as the hashtag, and I'll check out what people are saying. Honestly, sometimes I still can't figure it out at that point. So, the next thing I'll do is check on trade volume. If that's about normal, I've learned to just chalk that up to biotech being biotech, because this is a wild industry.

Campbell: Yeah. I think that one of the things that newer investors, maybe we all fall into it to some degree, is to take a look at some of these moves, maybe in the aftermarket or the pre-market, and then start freaking out and start googling like crazy, trying to figure out, "What's going on with my stock?!" I think that it's always a great reminder that, if you can't find anything, if you've done your Twitter search, you've done your search on Google and you can't find anything that justifies the move, don't worry too much about it. The pre-market and the aftermarket are very illiquid markets. Very few people, very few shares, trade on those markets. And usually, the spread between the bid and the offer, or the price you can buy it for or sell at, is usually much wider than you'll see when the stock market's actually open for trading. Don't stress too much when you see a crazy move. That's been something we've talked a lot about, just having that longer-term view and trying to keep yourself from getting too emotional.

Harjes: Oh, absolutely. And this industry in particular can really pull your heartstrings. Foolish long-term investing preaches to take your emotions out of investing. But I feel like that's particularly hard in healthcare. These companies are saving lives, and they're vastly improving people's quality of life. It's really hard not to get caught up in the story of hope when sometimes there isn't the evidence to support it. 

So, another thing that I've learned is to be really wary of stocks that are working on emotional diseases, like Alzheimer's, for example, which impact so many families and has proven so, so difficult to treat. Companies that are focused on these well-known devastating diseases are doing amazing things. I absolutely am cheering them on. But the stocks themselves can tend to get a little bit ahead of themselves due to the excitement that people feel at the prospect of a cure. Does that mean that I'll never invest in a company working on an Alzheimer's cure? No. But it does mean that you really need to look at the data with the glasses of a scientist to make sure that the efficacy and the safety are really there before buying.

Campbell: Yeah. I think it's also helpful, this is something that I try and continually do, whenever you're reading a press release or the latest study or something that's come out from a particular company, remember that the company -- I don't think that they're doing in a way that's nefarious -- they're going to talk their own books. They're going to put their best foot forward in their press releases. There's a human element, like you talked about. We all know people who've been impacted by some of these very, very devastating diseases. We want to see new cures come through that can help them. We're inclined to favor those kinds of innovations. But we also have to keep ourselves in check a little bit and remind ourselves that, yes, this is cool science, but the odds are pretty strongly tilted against clinical trial success. 

We've talked on the show in the past about failure rates, and how many drugs fail in trials. I think it's important to recognize that in diseases like Alzheimer's, the clinical trial failure rate is, unfortunately, like 99%. As much as you want a company to succeed in finding these drugs, it's very hard from an investing standpoint to look at it and say, "Yeah, I'm going to go out and I'm going to chuck a truck full of money in it."

Harjes: Speaking of keeping your emotions out of things, I've also come to really appreciate journaling my investing thesis. If one of your investments starts to dip, and nothing has happened to destroy that investing thesis, I've learned to view that as a great buying opportunity. This is something that's a lot different than when I first got started investing. A lot of newer investors are disappointed when their stocks go down. But the Foolish investor, the long-term one, says, "Hey, great! There's a sale going on!"

Campbell: Yeah. When you look at the recommendations, for example, that are put out on The Fool's premium side, oftentimes, you'll see new stocks, obviously, but you'll also see stocks that have been talked about in the past, or where there's a small wading in it, where more money is being added to those positions. I don't think that you go out willy nilly and invest a huge proportion of your money in any idea just because it's falling. But if your thesis remains intact, if you've got a stock and an idea for owning the stock, and the stock trades down because of some kind of news that really is either temporary or doesn't have a lot to do with the reasons you're in it, sure! Put a little bit more money into it and average your costs down. I mean, we've seen this with mutual funds, over time, that if you dollar-cost average into mutual funds, you end up coming out ahead. Well, the same can hold true for great stocks.

Harjes: Absolutely! The thing is, stocks don't go up in a straight line. David Gardner has a wonderful saying that I don't have in front of me, and so I'm definitely going to misquote, but it's something to the effect of, stocks go down more quickly than they go up, but they go up far more than they go down. Of course, that's not every single stock. But that is, on the whole, how the stock market works. It does go up over time, but not in a straight line, and any individual component of that, a single stock, is definitely not going to go up in a straight line. So, you can take those dips and look at them as really great buying opportunities. 

I also want to talk about the opposite side of that, though, which is not to count your chickens before they hatch. I think it's really easy to claim that a stock that you found is such a winner, and go on and on about it. I have absolutely done that on this show. Then it dips back down again. That's just part of the cycle. You don't want to overweight to the highs or the lows. Just recognize that if you've picked a good company, it will generally go up and to the right.

Campbell: That's a great point to be making right now. If anybody who's been following the marijuana story over the past two or three weeks, we had a great show on a few weeks back, Kristine, you and I. These stocks have gone to the moon. It's very tempting to pat yourself on the back and say, "Yeah, because I knew that medicinal marijuana was going to be a big thing. Look at these winners." But the reality is that this is probably a long-term story. There's going to be plenty of downside to offset some of that upside. Keep it all in check, like you said.

Harjes: Absolutely. The next lesson that I want to highlight was a painful one to learn. This is: be prepared to lose all of your money on stocks that only have a single drug, or at least, all of the money that you put into that stock. This isn't to say to not bet on clinical stage companies that only have one drug in the pipeline. But, if you do, it's better be with money that you can afford to lose.

Campbell: Right. You can survive a 3% hit to your net worth, but it'll take you years to make back the damage if you go all-in in a stock. Unfortunately, Kristine, I learned that lesson the hard way.

Harjes: Oh, no!

Campbell: Yeah, back in the .com era, as a young guy slinging stocks and feeling overly confident in my ability to pick winners, I went all-in with a relatively good-sized portfolio in a stock that, sure enough, absolutely flopped. I lost everything in that account. The lesson learned, the painful and costly tuition paid, was never to make that mistake again. While I still like to embrace growth stocks, and I'll still include stocks that are working on crazy, disruptive, cool things, I limit my exposure to them. 

You and I talked on the show probably a year or two ago, about how many stocks is the right amount of stocks to own in a portfolio. I don't know if it's 20 or if it's 30 or if it's 50, but it's certainly not one. [laughs] And it's certainly not two.

Harjes: Yeah, absolutely. My own tuition payment was with a company called Ophthotech. I bought shares of them back in March 2015, with a pretty small position that I then added to. Not a lot, I was fairly responsible with this. It was on the hopes that a drug called Fovista, which showed success in treating wet AMD -- which is a very common eye disease, it's the cause of 90% of legal blindness -- Phase II trials had showed great efficacy. Novartis, Big Pharma giant, signed on as a partner. But then, in December 2016, Phase III data comes out, there is no significant improvement when you use this drug. The stock absolutely craters. So, I sold it pretty soon after. And I sold it for a loss at around 90%, which is painful, even though that was only a small percentage of my entire portfolio. 

But, with that, I want to draw another lesson. If you're going to fail, fail for a known reason. This goes back to your investment thesis. I knew that if Fovista succeeded, the stock would go up a lot. I knew that there was a chance that it failed, and the stock would go down a lot. That's what happens in biotech. I was fairly new to the industry, but not completely green. So, acknowledging why you might fail when you draw your investing thesis is pretty important for knowing when to sell.

I ran the numbers earlier today to see what would have happened if I had held on to Ophthotech on the hopes that they would be able to turn their ship around. That money would have been tied up for at least two more years. In the meantime, it's declined another 50%.

Campbell: It's a great lesson to learn. I think it really does speak to the idea of, know why you're buying and investing in stocks. Don't just buy it because you saw somebody tweet about them, or you heard from one of your friends, "Hey, there's this great stock and I just made 50% on it." Know the reason behind them. This is a great example, too. I lost money on that stock, as well. When the Phase III trial failed, that was the end of the catalyst, the reason for owning it. So, OK, move on! Move on to the next idea. There are plenty of other companies out there working on great stuff. The money that you invest in something else, you have a much better chance at that winning doing that than trying to double down on a broken idea. 

Harjes: You spoke a little bit earlier about diversification, which leads me to the next point, which is that you can spread your money out and take multiple bets, even within a specific space. If any of our listeners heard me speak at the last Fool Fest, you've heard this one: not all spaces are winner-takes-all. My example for this is, back when we were covering CAR-T therapy, as it progressed through the clinic, way before it was ever approved by the FDA, I presented the investing decision on this show as: first, do you want to invest in this new technology? That was a resounding yes. This is really cool, a huge opportunity, you should consider strongly getting into this space. But then, I framed the question as, which stock is your best bet for exposure to CAR-T? 

That second question is useful, but as an investor, you don't have to just choose one. When Gilead Sciences purchased CAR-T developer Kite Pharma after my own CAR-T investment, Juno Therapeutics, shut down its lead program, I was kicking myself so hard, thinking that I had chosen the wrong CAR-T stock. Todd, you and I had even debated on this show -- I remember you chose Kite. I chose Juno. But, lo and behold, Juno still had a solid CAR-T program, and they wound up being acquired for a hefty premium by Celgene. Both of them wound up being great investments.

Campbell: Absolutely! To your point, I own shares in both of those. I think that spreading it out does make sense. The temptation oftentimes is to hear the news, read a press release, "Oh, this great new drug! Look at the efficacy! Look at the safety!" and think that, all of a sudden, the market's going to dry up for these other drugs that maybe are also in development or that are already on the market. That's not necessarily the case. You can have more than one winner in a particular market. 

One of the biggest examples of that that jumps to my mind is the anti-TNF market. Anti-TNFs are used in autoimmune diseases. Probably the best-known one of those is Humira, which has $18 billion a year in sales. You'd think that with Humira having $18 billion in sales, there would be no room for any other anti-TNFs. But that's not true. Both Remicade and Enbrel are also anti-TNF therapies used in autoimmune disease. Those were both mega blockbuster drugs, too.

Harjes: It's just a ginormous market. There is room for multiple players.

Campbell: Yeah. Even more recently, you have Regeneron's Praluent and Amgen's Repatha debate, which you and I talked about on the show years ago, many times. The idea is, these drugs are going to compete against one another to disrupt the market for cholesterol lowering medications. Granted, these drugs have not become the billion-dollar blockbusters yet that people had thought. But, both of these drugs are selling at nine-figure paces. I think Repatha's sales in Q2 were clocking in at about a $600 million share pace. If you had sold Amgen because of Praluent, then you would have missed out on a massive rally in Amgen. Amgen is reaching toward 52-week highs and even further. I think that, yes, you have to recognize that you can invest in multiple players within the same areas.

Harjes: For sure. Our last lesson of the day is to not be afraid of "expensive" stocks. If you have found a great business that's solving a big problem in a large market and it has a clear growth runway ahead of it, you just can't get caught up in trying to apply traditional valuation metrics. This is, rather than an error of commission -- which is what some of the earlier mistakes I talked about were -- this is a lesson I learned through omission -- not making a decision that I really wish I had made. Companies like Veeva Systems, Intuitive Surgical, Illumina, Canopy Growth Corporation, these are all companies that we've talked about on this show as being great businesses, but they're expensive, so I never invested in any of them. But they have all absolutely crushed the market over the last year, three years, and five years since I learned about any of them.

Campbell: I think a lot of times, we try to overthink things. We come up with this great investing idea, this great thesis, a disruptive company that theoretically could have a moat around it. And then we talk ourselves out of it, because we don't want to be wrong. I don't want to be the last person to buy this stock right before it falls off the cliff and goes lower. Oftentimes, that is a mistake. You outlined a few different ones. There's other companies out there, too. Teladoc is another one that jumps to mind as a disruptive company. It's changing the way that patients see doctors. If you had looked at Teladoc and said, "Jeez, it's an interesting story, but it's a little pricey," you would have missed a doubling in its share price. 

That's not to say that income investors or people managing portfolios that are risk-averse should not look at valuation. But if you're a growth investor, and you're looking at disruptive companies, like you said, using these traditional metrics isn't necessarily the way to winning. 

Harjes: And of course, you have to tie that together with the earlier lesson that we said, about not being too emotional and caught up in the story and investing in stocks whose valuations have gotten way ahead of them. But, ultimately, I think the real difference comes in, is this a good business? A promising business that is disrupting the market? Does it have a competitive moat? Is it a big market ripe for a solution? This brings me back to David Gardner again, and his entire Rule Breakers philosophy. If you can find these outstanding businesses that are just getting started, they might look astronomically expensive on a price to earnings ratio, or maybe they don't even have positive earnings yet, or price to sales might be really high. But you can't let yourself be tied to those metrics because you'll end up missing some awesome opportunities.

Campbell: Right. If sales are $100 million, but the market opportunity is $40 billion, you don't want to base your valuation on the $100 million number. You want to be smart and look out further out and say, "OK, if that $100 million could grow to a billion, then what's the valuation look like?" That's why you can't necessary trust long-term forecasts. A lot can and will happen, especially in biotech, with clinical trial failures and everything. But you have to take a little bit of a longer-term view of these kinds of things. Say to yourself, "OK, well, my reason for owning the stock is still intact. If I really do think that this could be a disruptive company, then why wouldn't I buy regardless of the fact that it's got a P/E ratio that's a little high?"

Harjes: Yep. If you can take that forward-looking long-term picture, and also layer in how much risk is associated with it, I think that's the secret sauce.

Campbell: Yeah, especially when you talk about the other lesson that you talked about, with diversification. Even if you're wrong, like I said earlier, 3% isn't going to kill you.

Harjes: Exactly. That's tuition at that point. Truly, all of this is just scratching the surface of the lessons that I've learned. I am so thankful to have had this experience. If you haven't heard already, Shannon Jones will be taking over the Industry Focus: Healthcare show. Jason Moser will be the new Financials host in her place. The newest editorial team member, Nick Sciple, will be taking over the Energy show. Lots of exciting changes to the lineup. 

As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm an investment analyst with Motley Fool Venture Fund management, and affiliate of The Motley Fool LLC. The views expressed herein are my own, and not necessarily those of Motley Fool Venture Fund management. 

A huge thank you to our man behind the glass, Austin Morgan, for all of the work he does each and every day to make this show sound good. Another huge thank you to Todd Campbell for being my partner in podcasting for three and a half years and teaching me way more lessons than we could ever fit into one episode. 

Campbell: I'm going to miss you, Kristine!

Harjes: And, of course, thank you to all of the listeners out there, longtime and brand new. I'm Kristine Harjes, and for what is probably the last time for now, Fool on!