I’ve started an experiment where I’m keeping a public portfolio of large cap stocks via the Motley Fool CAPS system- you can view it here. I would like to see if I can generate value on the long side… something that I find much, much more difficult than shorting.
My criteria are:
- Pick only the quality businesses in a particular sector. For example, Dollarama is the clear leader among discounters.
- Not overpriced. For that reason, Amazon and Netflix don’t make the cut (just look at what happened to Amazon during the Dot-Com Bubble).
- I avoid industries where there are no clear industry superstars. Oil and mining stocks simply don’t make the cut as none of them are quality businesses.
- Lastly, I avoid dying or shrinking industries. Profits ultimately don’t grow in dying industries and therefore those stocks almost never do well.
According to the Commonwealth Fund (an endowment-supported US foundation), US healthcare spending has increased to 16.6% of GDP in 2014. Other countries have seen less rapid increases in healthcare spending. For the most part, inflation is being driven by doctors with a vested interest in pushing medical services, expensive treatments, and pharmaceutical drugs. To my surprise, what I’ve found is that many aspects of modern medicine aren’t supported by rigorous scientific evidence. While the FDA drug approval process superficially appears to be scientific, it often isn’t. One way that pharma companies game the system is to prove that a drug (e.g. statins) affects a dubious biomarker (e.g. cholesterol) rather than prove that the drug causes more good than harm (e.g. lower mortality).
Unfortunately, mainstream views on science and medicine are quite ignorant of what goes on. We are taught to only trust medical advice from “trained and licensed professionals”. Much of society worships technology and has blind faith in the claims made by medical authorities. I would argue that this environment is a fertile ground for the trend in healthcare inflation to continue going forward. And if that trend continues, it is likely that American health insurance stocks will continue to do quite well.
Pharmaceutical companies researching active placebos may also do quite well.
While I don’t think that Dollarama is extremely compelling at the current P/E of 26.5, I do own the stock because I am trying to diversify. The company’s earnings growth is impressive and I like the new CEO, even though his father passed on the family business in 2016. And while the related party transactions continue under Neil Rossy, they haven’t meaningfully impacted shareholder returns in the past two decades.
Americans would like to think that their healthcare system resembles a free market system. Canadians would like to think that theirs resembles a single payor system. In reality, the reverse is true when it comes to prescription drugs. In Canada, most Canadians pay for their drugs directly (out of pocket). You could think of many Canadians as being uninsured when it comes to buying drugs. In the US, most Americans receive prescription drug benefits from their employer, with the administration of those benefits being handled by a private company. This is essentially private health insurance that employers are legally forced to pay for. I would argue that this is the main reason why Americans pay dramatically more for an EpiPen than Canadians do (the listed price is roughly $600 for a pair while Canadians pay around $200 for a pair). Private health insurance leads to higher costs. When for-profit companies are compensated on a fee-for-service basis, they are incentivized to spend very little money on lowering drug prices for their clients. In turn, drug makers take advantage of the situation by charging higher prices in the US than the rest of the world. The drug makers exploit the payor. Meanwhile, the insurance companies and PBMs spend very little money on protecting their clients.
This makes me more confident that the American government and states will continue to enact laws that benefit pharma companies, health insurers, and PBMs. American citizens have the mistaken belief that their system resembles a free market. On top of that, many people have difficulty understanding the US healthcare system. Explaining healthcare shenanigans (here and here) is like trying to explain options: many college-educated people have great difficulty in grasping the concepts. Change is unlikely to happen when American voters don’t understand the problem and its solution. While the morality of US health insurers is questionable, their favorable economic dynamics may persist for a long time.
Human beings are wired to hold self-serving beliefs about the world regardless of the accuracy of those views. While it is easy to see these tendencies in other people (e.g. flat earthers, Donald Trump’s anti-vaccination views, conspiracy theories), all human beings are wired to have blindspots when it comes to the inaccuracy of their own views. Why? Ideologies are often arbitrary but they serve social and political purposes. Nelson Mandela was once on US terrorism watchlists; nowadays, he is celebrated as a freedom fighter and human rights activist. Clearly, it’s not possible for Nelson Mandela to be both a terrorist and a hero. Yet, society conveniently ignores conflicting evidence when it distorts history to fit a particular political agenda. My theory is this: human beings participate in the mainstream ideology when it benefits them. When it doesn’t, social outcasts and misfits band together to form their own alternative ideology that benefits them. In both scenarios, the ability to ignore, downplay, and dismiss conflicting evidence lessens the mental burden of upholding a particular ideology.
I must admit that there is a somewhat useful tidbit of information in Pretium’s environmental filings that I discovered through Viceroy’s hit piece: Pretium was mining ore at a rate of only 2520tpd (tonnes per day) in the second half of 2017. I would note that management has repeatedly talked about expanding the mill to 3800tpd, possibly because institutional investors don’t understand why Net Present Value matters more than growth. Unfortunately, the mill expansion plan looks crazy when the underground mining was 2520tpd versus milling being done at 2895tpd; this indicates that underground mining has been the bottleneck. Management has not been forthcoming about this bottleneck. Nonetheless, I don’t think that this changes the short thesis much as it is overshadowed by the litany of Pretium’s other disclosure issues (e.g. the Ivor Jones resource model has the ultra-high-grade Cleo vein in a zero-grade domain).
This blog post will also discuss why I covered most of my Pretium short and has a section on why Viceroy’s research is nonsense. Continue reading
Viceroy’s research can be found on archive.org or Viceroy’s website.
First off, there is the issue of plagiarism. It’s so strange that Viceroy also happened to stumble across Simon Dominy’s paper on the Brucejack deposit. (To be fair, Viceroy did generate original research of very low quality.)
Secondly, the Viceroy report contains major inaccuracies. It insinuates that Strategic Minerals LLC improperly inflated the bulk sample results.
The facts surrounding Strategic Minerals LLC are as follows: […]
Grade results for the Brucejack mine from Strategic Minerals LLC were far higher than those reported by Strathcona’s tower sample.
In reality, grade results were very similar between Strategic Minerals and Strathcona. Table 9 of Dominy’s paper (draft version with working images, final version) shows that the difference was -10%… well within the expected error coming from a high-nugget deposit. Despite referencing Dominy’s paper, Viceroy seems to have reached some strange conclusions.
In the past, I have criticized Viceroy because they have not been transparent about their relationship with CTS Labs. Now, my problem with Viceroy is that they didn’t read up on mining or hire a fact checker before publishing their report. Viceroy’s reckless and irresponsible behaviour gives short selling a bad reputation and may make life more difficult for other short sellers.