Rule #1 Finance Blog

With Investor Phil Town

YOUR HOMEWORK: PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. (PPDI)

Here’s a homework submitted by one of my long-time readers, Tom from Grand Rapids.

Hey Phil,

It’s been a while since we last chatted, mostly because my wife and I were busy welcoming the newest and (hopefully) FINAL addition into our family this past November!

At any rate, now that I’ve got yet ANOTHER college tuition to fund it’s time to get back into the swing of things. Panera (PNRA) has become one of my best "friends" over the past few months and I’m gonna stick with it for the foreseeable future. However, I realize that I need to have a few other options available in case the bottom drops out – not to mention the fact that I want to continue to sharpen and hone my "skills" so I can become an Investment Superhero someday too!

Here goes my latest catch:

Pharmaceutical Product Development Inc. (PPDI)

PPD could be considered as a Pharmaceutical version of Cognizant Technologies (CTSH).
They are a pharmaceutical contractor service provider — in other
words, they provide the resources to conduct the behind-the-scenes work
of drug development and manufacturing such as managing clinical trials,
developing drug formulations, and filling syringes. These are the guys
that "Big Pharma" such as Pfizer (PFI) and Wyeth (WYE) turn to in their times of need.

Meaning:

Biotech is a multi-billion dollar industry that is only going to get
bigger as we continue to live longer. This fact alone creates inherent
meaning to ALL of us who have not yet received our death certificates.

Moat:

I’m a little vague on a deep moat, but they do have a consistency and
dominance that gives them the ability to recruit strong intellectual
capital. To me that translates in the whole relationship equation which
is a tough to ignore.

Management:

Seems to be the best of the best from what I can tell. The market
responded favorably to the recent appointment of Sara Vidmar to the
Executive Director post as it did to other top level positions that
were filled in 2005.

MOS:

Numbers look goooood to me!

  • Equity: Doubled once every three years = 24% growth (Rule of 72)
  • Debt/Equity: 1%
  • ROIC: 
    • 0 year = 16%
    • 5 year = 21%
    • 1 year = 21%
  • Sales Growth:
    • 0 year = 16%
    • 5 year = 21%
    • 1 year = 16%
  • EPS Growth:
    • 10 year = 3%
    • 5 year = 32%
    • 1 year = 111%
  • Valuation:   
    • Sticker = $101
    • Current = $68

So there ya go, please tell me if I missed something!

Thanks a million,

Tom VB

Here’s my response:

Well, there goes another one of my watchlist favorites!  I really like
PPDI.  You definitely did your homework, Tom.  I would like it a lot if
you dig in better on the question of Moat. 

How does PPDI protect
itself from competition?  Or does it?  Because if it doesn’t have a
moat, our predictions are pretty much not going to happen since what
happens to a no moat businesses is that their earnings growth gets slower
and slower and slower
.  This lowers the expectations and thus the
multiple that buyers are willing to pay goes down.  Which further
lowers the price and the whole thing spirals down down down.  This is
why businesses that were selling for $100 a share can continue to grow
their earnings for years and years and years and the price of the stock
doesn’t go up.

I was being interviewed on a radio show the other day and one of the
hosts took the position that big cap stocks like Microsoft were
undervalued and are going to go up… get this… because they hadn’t
gone up in price in 6 years.  Oh.  I see.  So because it was at $55 in
2000, Microsoft must go up now.  Oh okay.

Notice that there is zero reference to what Microsoft was worth in 2000
when it was selling for $55.  And there is no reference to what
Microsoft is worth today when it is selling for $28.  It’s as if these
guys live in an alternate universe where price and value are always the
same.

No one in that universe ever pays too much or too little.  They
always pay just right.  No matter what kind of a dumbass they are, they
always pay just right.  No matter how greedy or fearful, they always
pay just right. 

This is the EMT universe.  EMT is efficient market
theory
and it is full of it, folks, and, get this, it was taught as
gospel at almost every business school in America for the last 30
years.

That’s right.  All the folks who are running your mutual funds
were taught that the only way they could get a really good deal on a
stock was to learn something about it that no one else knew yet, and
then move quickly before the word got out. 

They still believe it.
They just can’t believe that the market could actually massively
underprice anything.  They always have an excuse for why any stock is
priced where it’s priced.  And usually, to be fair — because these are
smart people, a lot smarter than me and you by the way (or at least
a lot smarter than me) — the prices are usually right.

But usually right is a lot different than always right — and we can get
very rich on the difference.

Now I want to get a bit real here.  You and I, as I just pointed out,
are not as smart as most fund managers.  Therefore we can rightly
conclude that even when we THINK we have a wondeful business with a big
Margin of Safety, sometimes we don’t.  And you and I aren’t going to be
able to tell the difference.  But we do have one great thing going for
us: If we really follow the 4Ms, we will make money on this business
someday… and if we follow the arrows, we won’t lose money on it
today.  That gives us a huge advantage over almost any fund manager.

All this to tell you, Tom, that the more work you do to figure out the
Moat, the more likely you’ll be buying GREAT businesses.  The MOS Price
follows from that.  And then you are going to get rich, my friend.

Now go play.

Phil