Chip and Dan Heath give valuable advice on making decisions in their book "Decisive: How to Make Better Choices in Life and Work". In the book, the Heath brothers recommend taking four actions to make better decisions: Widen your options, reality-test your assumptions, attain distance before deciding, and prepare to be wrong.
These principles are good ones for investors to follow. In particular, I think the advice to prepare to be wrong is wise. With this in mind, I picked one of the stocks I personally own, Gilead Sciences (NASDAQ:GILD), to examine in order to identify how things could go awry. What could possibly go wrong with Gilead? Here are three possibilities.
1. Patent problems
One possible scenario that could really hurt Gilead Sciences' share price would be a major loss in one of several patent lawsuits over hepatitis C drugs Sovaldi and Harvoni. What would be the worst case if this happened? Gilead could be prevented from selling the products unless it was able to obtain a license from the company, or companies, winning the patent litigation. Such an event would put over $12 billion per year in revenue at risk.
Two patent lawsuits are most noteworthy. Merck (NYSE:MRK) has demanded that Gilead pay royalties on sales of Sovaldi. Gilead responded with a lawsuit seeking to have Merck's patents declared invalid. This litigation is scheduled to go to federal court in March 2016.
Gilead also initiated a lawsuit against AbbVie (NYSE:ABBV) in 2013 over patents involving Harvoni. AbbVie countered with two lawsuits of its own in 2014. The cases have been combined and are headed to court. Losing to Merck or AbbVie would present massive problems for Gilead.
2. Concerning competition
Gilead managed to get a nice head start on competitors by winning regulatory approval for Sovaldi before its major rivals secured approval for their hepatitis C drugs. However, the biotech isn't totally insulated from the danger of other drugs stealing enough market share to inflict serious wounds.
AbbVie landed a punch in December when giant pharmacy benefits manager Express Scripts selected Viekira Pak over Sovaldi for its formulary. That deal resulted in Gilead's shares plunging more than 15% -- at least temporarily. Since then, Gilead has forged its own deals with other payers. AbbVie still represents a threat, however.
Meanwhile, Merck appears to be on track to submit for approval of its hep C regimen grazoprevir/elbasvir within the next few months. The big drugmaker recently won two Breakthrough Therapy designations for the combo. Perhaps the chief worry for Gilead is that the potential addition of another hepatitis C drug on the market could lead to another round of pricing battles between the major players.
3. Bad buyout
One other possible way Gilead could go astray is by making an ill-advised acquisition. The biotech currently sits on a cash stockpile of over $10 billion. It wouldn't be surprising to see Gilead spend a big chunk of that money to buy a smaller biotech.
If Gilead does move ahead with an acquisition, the challenge will be to make it a smart one. The market could penalize Gilead if there's a perception that the company has spent too much money on a foolhardy bet. Another potential downside associated with a bad buyout is that it could divert Gilead's focus to the extent that it loses its mojo.
Don't forget the other three principles
Those are just three scenarios where things could go badly for Gilead. There are others. However, it's important to remember the other three decision-making principles given by Chip and Dan Heath. In particular, reality-testing assumptions makes a lot of sense.
While it's true that Gilead faces potential patent problems, consider the previous outcomes on patent issues related to Sovaldi. Gilead has already won two U.S. Patient and Trademark Office decisions concerning its Sovaldi patents. It also prevailed in patent skirmishes in Norway and the United Kingdom. These precedents don't mean Gilead will necessarily win in the future, but they are encouraging.
As for competition, Gilead seems to have outmaneuvered AbbVie in the payer battle for now. While AbbVie landed Express Scripts, Gilead secured deals with many other big payers. Even throwing Merck into the picture at some point in the future, Sovaldi and Harvoni should remain the biggest winners in the hep C market, which it's important to remember is large enough to support multiple players.
Finally, take into consideration Gilead's past buyout experiences. In 2011, for example, the biotech bought Pharmasset for $11 billion. Many thought Gilead paid too much. With that acquisition, though, Gilead secured what would become Sovaldi. That turned out to be a very smart decision.
Yes -- things could go wrong for Gilead Sciences and its stock. It's good to consider those possibilities. However, also ask what could go right for Gilead Sciences? My take is the answer to that question makes Gilead a compelling stock to buy and hold for the long run.