Buffett and biotech? No way, right?
Before we totally dismiss the possibility, though, let's consider what Warren Buffett likes to see in the companies he buys. He wants companies that should perform well over the long run, have share prices below the true value of the stock, and that sell products with a competitive advantage.
Are there biotech companies that meet those criteria? I think so. Here are three biotech stocks the Oracle of Omaha just might be able to love (if he doesn't already).
1. Johnson & Johnson (NYSE:JNJ)
At one point, Warren Buffett did love Johnson & Johnson. And he does still own nearly $33 million worth of the stock. But that's a far cry from the more than $1 billion worth of J&J shares Buffett claimed just a few years ago.
What happened? After a series of miscues and product recalls by the big healthcare company, Buffett publicly stated in 2012 that J&J made "too many mistakes." That was then, though. Some of the things that caused Warren Buffett to love J&J in the first place appear to be back in full bloom now.
A strong argument can be made that Johnson & Johnson will continue to be a company that performs well over the long run. It has solid financials with products your grandparents bought and your grandkids (and their grandkids) will probably buy, too. In terms of valuation, J&J claims an earnings multiple that's well below the average for major drugmakers.
Can we really call Johnson & Johnson a biotech, though? Granted, it's basically a healthcare conglomerate with large businesses in consumer goods, medical devices, and pharmaceuticals. However, consider that pharmaceuticals is by far the company's biggest segment -- and the only one that experienced year-over-year sales growth last quarter.
Peaking under the hood at those growing pharmaceutical sales reveals just how much of a biotech J&J is now. The company's top three best-selling drugs last quarter all belonged to its subsidiary Janssen Biotech. I'd say J&J qualifies as a biotech -- and one of which Warren Buffett could grow fonder.
2. Gilead Sciences (NASDAQ:GILD)
One biotech stock that hasn't been in the Oracle of Omaha's portfolio in the past but is one he might want to consider is Gilead Sciences. While Buffett's Berkshire Hathaway (NYSE:BRK-A) stock turned in an impressive performance over the last five years, Gilead did much better -- five times better.
There's a lot Buffett could find to love about Gilead Sciences. Strong growth? Check. Solid balance sheet? Check. Product competitive advantages? Check that one off, too. The biotech dominates two huge markets with its HIV and hepatitis C drug franchises.
While Gilead might not measure up to the criteria for Buffett's mentor, legendary value investor Ben Graham, the stock looks like a good bargain right now. Gilead's price as a multiple of both trailing and forward earnings stand much lower than most other biotechs and most other S&P 500 companies, for that matter.
If Warren Buffett and his business partner Charlie Munger wanted to buy a pure-play biotech stock, there's probably none that would be as good of a fit as Gilead.
3. Rockwell Medical (NASDAQ:RMTI)
Like Desi used to say to Lucy, there's some 'splainin' to do when it comes to Rockwell Medical. Yes, this biotech has consistently lost money. No, it probably won't turn a profit this year. So, why in the world would Warren Buffett possibly like this company?
The key to answering this question is looking at Berkshire's current big holdings. Dialysis services provider Davita Healthcare (NYSE:DVA) ranks No. 8 on the list. Berkshire Hathaway's position in Davita tops $3 billion -- and growing.
Davita's bottom line stands to be benefit tremendously from Rockwell Medical's recently-approved iron replacement drug Triferic. Dialysis providers like Davita currently spend a combined $2 billion annually on expensive erythropoiesis-stimulating agents, or ESAs. Triferic should allow these providers to significantly reduce the use of these ESAs and save lots of money.
Buffett should like Rockwell Medical because of the Davita connection. However, he could find some things to appreciate about Rockwell on its own merits. The company is widely expected to reach profitability in 2016 and see average annual earnings growth of 25% over the next five years.
That rosy outlook makes the stock look like a pretty good deal at its current price. Warren Buffett doesn't need to ask investment analysts about anything, but if he did ask them about Rockwell Medical, he might be intrigued. The worst analyst one-year price target for the stock represents a 73% increase over the current share price.
I don't think the analysts are crazily optimistic. And I suspect if Buffett checked Rockwell Medical out for himself, he wouldn't think so either.
A little understanding
Warren Buffett likes to understand the businesses of the companies he buys. One could argue that biotech isn't a good fit for his portfolio because he doesn't understand it. Maybe so, but I don't think that gives enough credit to a man who is probably the greatest investor of our time.
Buffett hasn't been averse to buying pharmaceutical companies in the past. In addition to Johnson & Johnson, Berkshire also holds a position in French drugmaker Sanofi. It's not that big of a leap from understanding a more traditional pharmaceutical company to understanding a biotech, and the lines are becoming increasingly blurred between the two.
Buffett and biotech? I think it sounds like a great idea, with J&J, Gilead, and Rockwell Medical tasting as good as a few pieces of See's Candy.
Keith Speights owns shares of Gilead Sciences. The Motley Fool recommends and owns shares of Gilead Sciences and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.