There’s a pretty good chance Warren Buffett knows a few things about investing that we don’t. This makes the fact that he doesn’t have a single biotech stock in his portfolio somewhat conspicuous. Why would the Oracle of Omaha eschew such a high-tech and high-growth industry altogether?
As it turns out, there is a plethora of reasons biopharma companies are a poor fit for the investing style of Berkshire Hathaway (BRK.A -2.76%) (BRK.B -2.81%). Even if your approach might be a bit different, it’s worth understanding a few of his deal breakers to improve your investing process.
Let’s take a look at three of his most likely arguments against buying biotechs.
1. They’re super risky
Biotech stocks are risky, and there isn’t really any way of de-risking their line of business, both of which are things that Buffett almost certainly hates about them.
The riskiness stems in large part from the nature of the clinical trials process. It’s really hard to develop a new medicine that has rigorously proved to be both safe and effective at its intended purpose. Most attempts end up failing along the way, burning precious research and development (R&D) dollars, not to mention dropping companies’ share prices.
A program that’s entering phase 1 of its clinical trials has only a 13.8% chance of eventually getting commercialized — and Buffett is known for liking slam dunks far more than long shots.
Clinical-trial risk declines as programs advance through the process, but even companies that succeed in bringing their medicines to the market can be terrible investments, which is another risk factor that would grind Buffett’s gears quite severely.
For example, Novavax succeeded in commercializing its coronavirus vaccine, but its shares are down 91% over the last 12 months because competitors like Moderna beat it to the punch, saturating the market before it could gain a large enough share to flourish.
Looking at the 10 years of Novavax financial data leading up to its failure to gain traction in the market wouldn’t have given any investor a clear picture of what would happen, and that means Buffett’s diligence-heavy approach to investing wouldn’t help to mitigate his risk exposure by much. And the same is true of most biotechs.
2. Their revenue and cash flows are anything but stable
Another Buffett quibble with biotechs might be that their financial performance is often closer to a roller coaster than the consistent, predictable, and plodding growth that he prefers.
Once again, it’s part of the nature of the beast that biotechs don’t have much in the way of income whatsoever until they succeed in commercializing one of their projects. Then they experience a massive spurt of growth as sales of their product ramp up — until the legal protections preventing competitors from making a generic copy expire, at which point revenue from the drug plummets, often to near zero.
Even gargantuan and highly successful businesses like Moderna fall victim to this pattern, though not always as a result of generic competition. Whereas sales of its coronavirus vaccine brought in $18.8 billion for 2022, Moderna could report revenue of only $7.6 billion this year, per Wall Street’s average estimate.
Largely everyone who wanted to get vaccinated with its shots did so, and the market for doses is shrinking as a result. It’s very likely that Moderna will commercialize new vaccines that shore up its revenue again in the future, but for an investor like Buffett, the fact that the star performer of the last few years can become a fallen star practically overnight — through no fault of its own — is likely a big turnoff.
3. Competitive advantages are even harder to come by
Buffett loves competitive advantages, especially economic moats that enable businesses to retain their market share even in the face of determined opposition.
But the only competitive advantage that biotechs can sometimes bring to bear is their intellectual property rights, which prevent competitors from making exact copies of their medicines and technologies, but only for a finite period of time.
Think about it. For biotechs, there’s no real way to have traditional sources of competitive advantage like branding power or customer lock-ins. And while there might be a lot of claims about developing technologies that drive down the costs of discovering and commercializing new drugs, often it can take years before those claims are proved, and many aren’t.
The consequence of not having a competitive advantage is that biotechs can often end up competing in the same disease markets without any real way to edge out the other companies. And for Buffett, that’s probably a big risk, because there’s no clear path to success, nor is there any guarantee that a success today will remain one in the future.
Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends Moderna. The Motley Fool has a disclosure policy.