The big challenge this year as opposed to other years is how much will opposing forces interfere wit...
Pile's Picks: Apple and MannKind
12/09/2013 10:00 am EST
Nate Pile, editor of Nate's Notes, highlights two favorite stocks—a tech leader that is a solid growth play for long-term investors, and a high-risk gamble on a drug developer.
Steve Halpern: We're here today with growth stock expert Nate Pile, editor of Nate's Notes. How are you doing today, Nate?
Nate Pile: Fine, thanks.
Steve Halpern: You've argued that over the long-term, the markets are efficient, but that over the short-term, markets tend to reflect fear and greed. Could you explain this a little for our listeners, and highlight both your short-term and long-term opinion of the current market?
Nate Pile: Sure. I'm certainly not the first person that's made the observation, but when I started my career in the stock market, a little over 25 years ago, for better or worse, I was lucky enough to work for a newsletter that followed only biotech stocks.
And, as you know, during the five to ten-year period it often takes for those companies to get a new drug to market, there really isn't much to base stock price on other than a hope that the drug will work, or fear that it's going to fail somewhere along the way.
Over the course, at the time, I didn't know any better; but after watching the sector go through, not one, but two bull markets during the first eight or ten years I was investing, it became apparent to me that the stocks rarely traded over what one might call fair value.
Instead, they tended to go from extremes, from undervalued to overvalued and back again; only occasionally trading at what the consensus fair value was.
While biotech stocks are admittedly unique, in the sense that, those companies really do exist for years before they generate a penny in sales, if they ever generate sales at all.
As time went by, I came to realize that the same thing happened to all the stocks that I was following, because I had branched out at that time and was following semiconductor stocks, and ice cream companies, brewing companies, but the pattern was the same.
I was still a fairly young investor at that time, but I was noticing that's what was going on; namely, you could do all the number crunching you wanted, to come up with a fair value for a stock, by looking at it's book value, or future earnings growth, any of the things people have looked at over the years, but once you finished your calculation and then looked at where the stock was trading, very rarely, if ever, was it trading at that number. It was almost always above or below it.
Steve Halpern: It's not unusual then for you to hold a stock for many years and even build positions over time.
Nate Pile: Correct. What I like to do is, I like to get into stocks where I think the company has great long-term potential, and then, when stocks are acting well, we try to add to those positions.
When they're not acting so well, we pull in our horns a little bit, but we always have a position in the stock, because we can be wrong about assessing the market's conditions, plus, especially having been in biotech stocks in the early part of my career, there's nothing worse than selling your entire position and finding out the next day that someone made a buyout offer for double where the stock was trading.|pagebreak|
Steve Halpern: Now, one way to look at your long-term view would be to compare it with a specific holding. One of your longest held positions, and I believe the largest holding in your model portfolio is Apple (AAPL). You believe the market is mispricing that stock. Could you explain your outlook for Apple and why you consider it an aggressive buy at these levels?
Nate Pile: Yeah, as you know, it's been a real interesting story to watch over the years. We got into the stock in 1998, and of course, it has been an especially challenging time to own the stock over the time period since Steve Jobs passed away.
However, now that some time has gone by, and we've had a chance to see that the company is, in fact, still putting out products that people are willing to pay a premium for, and while there's some question whether they're the leader or not, they're clearly still at the forefront.
I think it's fair to say that it was premature to equate the death of Steve Jobs with the death of Apple. To be sure, there'll never be another person like him, but at the end of the day, the company is sitting on a pretty nice business franchise.
And, as I was starting to discuss a little earlier, pretty much no matter how you slice and dice the numbers on Apple, you almost always come up with saying, at the very most, this is a fairly valued stock, but almost certainly, this is a cheap stock, and it's hard to argue that Apple's overvalued at current prices, just based on a fundamental basis.
Put that together with the observation that stocks tend to go from undervalued to overvalued, and right now what I see is a stock that is cheap or fairly valued, but trending in the upward direction and history suggests that it will continue to do that until it reaches overvalued levels, and I don't see that we're anywhere close to that at this point in time.
To be sure, something could change tomorrow, but they're still a leader of the pack in just about every market in which they compete, and, as we saw with the launch of the recent iPhone, people are still willing to pay a premium for their products, and that doesn't seem to be diminishing in any way at this point in time.
Steve Halpern: Now at the other extreme of the risk spectrum, you've been recommending a very high-risk, development-stage drug company called MannKind (MNKD). It's a speculation that you've noted could have homerun potential or huge downside risk. Could you tell us a little about this idea?
Nate Pile: Yeah, MannKind is a company that's developing an inhaleable form of insulin, which is a concept that's been tried a couple of times before, and met with dismal failure in the marketplace.
There are a lot of reasons for that; patient compliance. It was hard for their patients to want to use this product, because it was this giant device you had to carry around to inhale your insulin; it wasn't convenient to use.
Mankind has addressed a lot of that and they've got a form of insulin that I think has a lot of benefits. It's going to play out well for the company.
Looking at the fundamentals of the story, I think it's got homerun potential; that the drug is approvable and it's going to be much more accepted in the marketplace than past attempts have been by other companies.|pagebreak|
That being said, again, following biotech stocks for quite a while now, I've learned that just because I think a drug is approvable, it doesn't mean the FDA is going to agree with me, and that's really where the biggest risk comes in for this stock.
If the FDA turns them down, it's currently around a $5 stock, and it will probably trade down to a dollar or less, and that'll be it for the company.
On the other hand, if it works, there's tremendous upside potential, coupled with the fact that there's a lot of people betting against the company; there's a large short position, and most of that pessimism seems to be based on the idea, first, that the drug wasn't going to be approvable.
Those concerns got shot down recently, when the company announced positive phase three data that met all the end points they discussed with the FDA.
And so now, the last real hurdle is, will it be approved, which I think it will be. And then, will patients start using it; will doctors prescribe it?
If that happens, I think, with that large short position, there's a chance for a good old-fashioned short squeeze to take place, and these sorts of stocks, again, a number of times over the last 20 years, you see stocks that, in a period of a couple of weeks, double or triple in value and once that happens, it's off to the races in terms of stock price, while they head to that overvalued level, before things reverse course again.
Steve Halpern: Again, so our listeners fully understand—a company like Apple is something where you would recommend building a long-term investment position, whereas, a company like MannKind is something someone has to consider somewhat of a gamble, that may or may not work out.
Nate Pile: Yeah, yeah, Apple is the largest position, in both of our portfolios I believe, or close to the largest position and is a very solid, long-term core holding we want to have in there.
MannKind is something you want to own a little bit of, so that if things do work out, you've got a low cost basis for your initial position, and should they get the product approved and it becomes accepted, it has the potential to be something that we would also make a large core position.
Right now, you know, again, the FDA is always a toss of the coin and if they get bad news you're going to end up losing 80% or 90% of your money, so you don't want to put too much on it at this stage of the game, but you want a little bit in there, because it's always easier to average up after a big move, if you've got a nice low cost basis.
Steve Halpern: Thank you for joining us; I really appreciate your time today.
Nate Pile: Yeah, thank you.
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