Few investors would intentionally go against the judgment of the most famous -- and, arguably the most successful -- investor in history, but if you've ever purchased a biopharma stock, you're likely to have ventured where Warren Buffett would refuse to tread. Buffett's legendary long-hold approach to investing is backed by a conservative approach to stock selection that places great value on earnings consistency and eschews chronically high costs. Specifically, the Oracle of Omaha disfavors companies with consistently high research and development (R&D) costs, intense competition, large capital expenditures, and high cost of goods sold (COGS) compared with sales revenue.
While that short list is far from a conclusive account of his preferences, it does indicate that the average biotech or pharmaceutical company would not make the cut. Does this mean that long-term investors eager to follow in Buffett's footsteps should avoid these companies as a matter of course? To investigate, let's take a look at a couple of stocks and compare them against his stringent guidelines.
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Is Pfizer a Warren Buffett stock?
Pfizer (PFE +1.56%) is among the largest pharmaceutical companies, but it probably isn't a Buffett favorite. While Pfizer's trailing 12-month R&D costs of $9 billion are actually relatively low in comparison to its total revenue of $49 billion, few would argue that it faces little competition within its field.
Likewise, there's no chance that Pfizer could stop spending so much on research and hope to retain its position in the market, because the very nature of its business is to make and sell new pharmaceutical products. In fact, according to an article published in the Orphanet Journal of Rare Diseases in 2019, the clinical-trial portion of drug development costs pharma companies an average of about $291 million per drug. This would be a major red flag for Buffett because it effectively locks the company into an expensive innovation arms race with its competitors, leaving it on the hook for difficult-to-predict failures in the product development race.
Unfortunately, the process of discovering new therapies is both capital-intensive and highly unreliable, and Pfizer's capital expenditures have only increased over time, totaling $2.4 billion over the past 12 months. Pharma investors might accept this as unavoidable, but in Buffett's view, routinely high capital expenditures make it harder for a company to be consistently profitable, thereby making it less likely that shareholoders will experience long-term compounding of their investment.
Finally, Pfizer's revenue hasn't consistently increased over the last 10 years, nor have its earnings. In summary, Buffett probably wouldn't touch Pfizer -- now or even in the past, when its industry was somewhat less competitive.
Becton, Dickinson fits Buffett's bill
In contrast, Becton, Dickinson (BDX +0.79%) might be a biopharma company that Buffett could get behind. Commonly referred to as BD, the company manufactures basic supplies including test tubes and stents for hospitals and laboratories, so it isn't highly reliant on R&D spending. In the past 12 months, it spent only $1 billion on developing new products out of its $17 billion in revenue -- significantly less than Pfizer. Though it does face competition from other healthcare giants such as Thermo Fisher Scientific, BD hasn't seen its profit margins suffer substantially in the past decade, perhaps thanks to its very diversified line of in-demand products.
PFE Revenue (TTM) data by YCharts
At the same time, BD doesn't need to spend much on manufacturing hardware to turn a profit, reporting only $955 million in capital expenditures over the last year. While it's true that Buffett might balk at the company's high COGS, which exceeded $9 billion in 2019, he would likely be pleased at its time-tested history of rising revenue.
Thus, BD is a biopharma stock that could earn Buffett's seal of approval, and it definitely earns mine. However, knowing Buffett's preference for purchasing stocks at a bargain, I think it's safe to say that he would prefer to wait for market conditions to provide a discount rather than purchasing BD at its current price.
