There is a common tendency for pharma companies to back out amortization of acquired intangibles from "adjusted earnings", and investors/analysts to quote the lower P/E multiples resulting therefrom, but this is a highly questionable practice (thread).
Unlike staples companies (like KO & PG), pharma companies' earnings lack very long term earnings duration. After LOE patent expiries, their earnings typically drop precipitously, and so they need to continuously replenish the pipeline & launch new drugs to offset the impact.
Ideally, they would do this purely through internal R&D, and some companies succeed at that. But in many cases, internal efforts are insufficient, as it is getting harder and harder to discover new novel & genuinely differentiated/innovative therapies.
What these companies will therefore do, if they are staring down a patent cliff and have an inadequate internally-generated pipeline, is make acquisitions of mid to late stage drug development companies with promising drugs to replenish their pipeline inorganically.
Naturally, this leads to large acquired intangibles balances (paid in cash), and in substance represents the "outsourcing of R&D". But the earnings they acquire from these new drugs are also finite-life, and they need to use the cash flows to repay the acquisition debt incurred.
The practice of not including the amortization of such intangibles in "adjusted earnings" leads to a meaningful overstatement in the sustainable cash generation ability of the coy, as it excludes the considerable cash cost of regularly acquiring in drugs to refill the pipeline.
It is quite possible for a drug company to report strong and growing "adjusted earnings" all the way into the bankruptcy courts (e.g. MNK), buckling under the weight of a tremendous debt pile accumulated in acquiring in drugs. It's also why coys like ENDP trade at 3x "earnings".
However, even at the big end of down, including companies such as MRK, PFE, ABBV etc, the practice leads to adjusted earnings meaningfully understating de-facto multiples. Most of these companies realistically trade at closer to 15-20x earnings than their headline 8-12x.
In a world where investors purport to care so much about business ethics & ESG, their ought to be much more push-back against these deceptive reporting practices than there are. It's actively misleading & the perpetrators ought to be called out on it.

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More from @LT3000Lyall

13 Apr
I've shared this old Buffett interview before (from 1985 I believe, and one of Buffett's first), but it recently turned up again in my YouTube feed, and it's such a great interview I thought it worth sharing again & offering a few quick thoughts (below).

One of the first things Buffett says is rule #1, don't lose, and rule #2, don't forget rule #1. This is a quote I've heard many times over the decades, but only fairly recently have I begun to really fully appreciate how fundamentally important this dictum is.
Every cycle, Buffett is widely criticized for "missing winners". This cycle, it's for "missing Amazon" etc. But that misses an important point: Buffett's approach/value investing is fundamentally about *avoiding the risk of overpaying* at all costs.
Read 12 tweets
26 Mar
Owning high quality but expensive stocks is great when multiples are rising. High returns & low biz risk - what's not to like? The Q is, how will investors react/behave if multiples start to decline and stocks go sideways/down for years. How long before ppl get tired of owing em?
Patience is in short supply in markets - due to both investor temperament and performance pressure. Most are unwilling/unable to hold stocks going nowhere/underperforming for years. People's perceptions & attitudes towards these stocks will change when multiples stop rising.
2-3yrs in, after years of stagnation, investors will start to see these stocks as dull/dead money, and start looking for cheaper stocks that have the opportunity for larger gains. Trends like this are self-reinforcing. This is how 10yr+ multiple derate cycles in quality happen.
Read 4 tweets
24 Mar
It's amazing what absurd things ppl will believe/argue when they emotionally want to be bullish. On Kuaishou below:
*User coverage is 90% but there is "room for platforms to increase user base". Infants perhaps? To not see saturation here is glass is half full in extreme.
(1/2) Image
*Average time spent is 67min per DAU, but this "could rise to 110min by 2025". It could also fall. There are only 24 hours in a day, and there will be more not less competition for our entertainment time in the future.

Really nutty stuff.

(2/2)
PS (3/3)
*Tiktok & Kuaishou have formed a duopoly, "although WeChat may muscle in". Just a casual remark in passing that "oh, and by the way it might not remain a duopoly, and might get a lot more competitive". But no need to worry, because there is no need to worry.
Read 5 tweets
17 Mar
A bunch of German municipalities have lost a significant portion of their deposits, which they parked with Greensill's now-insolvent bank. They did so because they wanted to avoid paying negative rates on deposits, & signed up for Greenshill's 0.1%.

wsj.com/articles/green…
Reaching for yield has always been dangerous/a problem. However, central banks have now created a situation where people/institutions are desperate for any means of avoiding their savings being whittled away. It would be surprising if this did not lead to negative consequences.
We actually now have a historically-unprecedented situation where the cost of capital is negative. Sitting on cash guarantees significant losses over time - nominal as well as real. It should not be a surprise that anything that generates a positive yield is in high demand.
Read 4 tweets
16 Mar
Great thread on banks. Agree with all/most. It is important that banks/financials/lending businesses are run by thoughtful risk managers, not growthy/marketing people. Many fintechs make me nervous for this reason. The former stand the test of time, the latter usually don't.
One of the repeating cycles you see is that after a bust where all the go-go aggressive banks/financials get wiped out, you'll eventually see a new cohort emerge arguing trad banks are too conservative/bureaucratic/slow moving; are leaving lending opportunities underserviced etc.
The actual truth is that those segments are usually underserviced because they blew up the last cycle's go-go cohort. And long term success in a leveraged biz like banking *requires* that you be conservative/bureaucratic/slow moving to make sure you don't make any big mistakes.
Read 5 tweets
6 Mar
Here is a a look at the NASDAQ's earnings trend. Interestingly, earnings have been falling since 2018 and are actually (1) down about 25% from their 2018 peak; and (2) currently slightly below 2016 levels.
This is actually not atypical late in a boom/bubble. The flood of capital into an industry usually drives down returns. Often that's ignored because people are focusing on the growth narrative/top line instead of earnings & returns on capital. Eventually earnings matter though.
It goes without saying that the consensus earnings estimates shown in light shade are likely to prove fairly delusional. I think we are most likely to see a continuing downward trend in earnings from here until we have a 2000-style bust & resultant industry capital rationing.
Read 5 tweets

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