Risks from "Too Much of a Good Thing"

Risks from "Too Much of a Good Thing"

April 05, 2024

Several of our clients hold what's described as "concentrated" positions in an individual stock. What this means is that perhaps more than 10% of their assets are in a single stock. Many of these stocks are in the tech or "big pharma" industries. Examples include Merck, Apple, Eli Lilly, Nvidia, Microsoft, and Facebook. While these stocks may have had big increases in value over time, they are also vulnerable to shifting tides and therefore can be a risky part of a person's assets.

One of the first steps in reviewing a new client’s investment portfolio is to identify risks that they might not be aware of. A concentrated position is one such large risk, much like “having all your eggs in one basket.”

We help our clients reduce their business and regulatory risk by methodically selling or otherwise reducing the amount of money invested in one stock. Ways that we have done this for clients include gifting to children (as they might be in a lower tax bracket), donating appreciated stock directly to a charity or other non-profit, setting up a donor-advised fund (DAF), or slowly selling the stock without triggering a huge tax bill.

Take big pharma, as described in detail in the following article recently published in Barron's, as one such large risk.

Big Pharma's Big Problems

The pharmaceutical business comes with an inherent ticking time bomb. Drugs—which may cost billions of dollars to develop and run through clinical trials—are only good for as long as they're under patent. Once those run out, pharma companies lose practically all of their pricing power. Cheaper generic copies of the same compounds flood the market in short order.

It makes pharma companies tough investments. That's the subject of this weekend's Barron's cover story by Josh Nathan-Kazis

Josh wrote:

Decades of efforts by these companies haven’t changed a fundamental truth: Drugmakers eventually lose exclusive rights to their best inventions. Think of rivals being allowed to sell perfect clones of Apple’s iPhone, or McDonald’s having to share its Golden Arches. New laws allowing Medicare to negotiate the prices it pays for some medicines—before patents expire—only exacerbates the issue.

Allowing companies to make cheaper copies of branded medicines has been a win for humanity, but it is an ongoing loss for investors—a fact that seems to get overshadowed amid hype for the next big drug. Over time, Big Pharma stocks haven’t worked as long-term investments.

Pfizer, Merck, Johnson & Johnson, and Bristol Myers Squibb have all trailed the S&P 500’s performance over the past five-, 10-, 15-, and 20-year periods, even if you take into account their generous dividends. European drug companies GSK and Sanofi have similar records. Eli Lilly and Novo Nordisk have been standout exceptions, but their performance has been boosted by the recent rapid success of weight-loss drugs. In just over a decade for Lilly, and just under a decade for Novo, those treatments will face patent expirations, too—and the pattern could restart.

The result is a boom-and-bust dynamic for many pharma stocks that makes them resemble trading vehicles more than long-term, buy-and-hold investments. 

Studies show that, on average, the first copycat competitor tends to follow a new drug's launch within 15 years. Once generic alternatives enter the market, pharma companies face a so-called “patent cliff.” That's an apt metaphor: competition from generics can lead to prices dropping more than 95%, Josh writes.

Take Merck, whose blockbuster cancer therapy Keytruda brought in 42% of its revenue last year. That's set to go off-patent in the U.S. in 2028. By 2030, drugs that had combined sales of more than $30 billion for Merck last year will go off-patent. That's a lot of revenue to have to replace.

For Bristol Myers, the total is more than $23 billion in revenue from drugs set to go off-patent by 2030. Pfizer needs to replace some $17 billion in sales by the end of the decade.

The new Medicare price-negotiation regime signed into law in 2022 adds another wrinkle for pharma companies.

While concentrated positions in certain big pharma stocks may have fueled impressive returns in the past, the inherent risks associated with patent expirations and changing regulations can significantly impact their future performance. Here at Gallant Financial Planning, we take a comprehensive approach to portfolio management, prioritizing diversification, values alignment, and mitigating risks. If you're concerned about the health of your investment portfolio, we encourage you to schedule a free consultation with us. We'll work with you to develop a personalized plan that aligns with your risk tolerance, values, and long-term financial goals.