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I love picking the right stocks. But in a year like this, when Wall Street is split between big winners and equally big losers, I’m more focused than usual on how the stock picks fit together.
We’ve had a lot of success in IPO Edge with what I’m calling “intelligent portfolio design.” The basic concept revolves around making sure the basket of stocks on your screen keeps moving forward no matter how the market twists.
One week, technology might retreat to make room for conventional consumer sectors to recover. Then the pandemic headlines shift again and money flows back to Zoom Video Communications Inc. (NASDAQ:ZM), Teladoc Health Inc. (NYSE:TDOC) and the vaccine makers.
We make money on both sides, and the portfolio as a whole has kept working at an annualized rate of 50% throughout the cycle. I’m rolling out something similar for my 2-Day Trader with the potential to increase the impact of every quick double-digit-percentage win we score.
The stocks and options don’t change. Subscribers still get the same simple and actionable trade alerts. But the relationships across positions get more robust as we confront more complex market conditions.
And everyone can take advantage of the basic elements. Let’s look at the very different roles vaccine maker Moderna Inc. (NASDAQ:MRNA) plays in two superficially similar biotech index portfolios.
Who Makes Money On MRNA?
The “standard” biotech industry benchmark is iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), which is up a healthy 21% year to date (YTD), beating nearly all sector funds, including the overall health care group.
MRNA played an insignificant role in IBB before the COVID-19 crisis made the company’s vaccine platform one of the few points of hope in a sick world. Now, after its 700% surge, it’s a $60 billion stock and one of the biggest components of the IBB portfolio.
Great, right? But IBB shareholders didn’t start with enough skin in the MRNA game to make real money. At best, this once-in-a-lifetime blockbuster move netted them a 4% overall return.
Meanwhile, IBB placed gigantic bets on stocks like Gilead Sciences Inc. (NASDAQ:GILD), which is down 6% YTD despite its high-profile coronavirus therapies.
GILD is a behemoth in the relatively small and scrappy biotech world, so big that many index makers now consider it a member of the exclusive Big Pharma club. As such, its growth profile isn’t anywhere near what pure biotech investors expect.
Because IBB is an index fund, it can’t sell GILD and put its money to work elsewhere. And because positions here are automatically weighted by size, dead money at the top becomes a real drag.
That’s when I noticed that another biotech fund, SPDR S&P Biotech ETF (NYSEARCA:XBI), is up 40% YTD, doubling IBB for pure performance, even though mighty MRNA is only 1.7% of the overall portfolio.
What’s the secret of XBI’s success? For one thing, it doesn’t count GILD as a pure biotech company anymore, so that big drag no longer plays any role in its aggregate results.
But the real key is that XBI is equal-weighted. Once the index managers decide a biotech company deserves inclusion, it gets the same room in the portfolio as each of its peers.
MRNA rated a significant role in XBI a year ago, well before its Wall Street profile translated to the kind of market cap that would attract IBB today. For all practical purposes, XBI shareholders were overweight this powerhouse stock, whereas IBB stayed underweight.
And because XBI rebalances every three months, shareholders automatically took profits along MRNA’s stratospheric trajectory. Managers sold enough shares to maintain a 1.7% weight and redistributed the proceeds evenly across other biotech holdings.
No prescience was needed to buy MRNA in the first place. Every biotech stock with roughly $70 million in market cap got a seat at the table, no matter how hot (or cold) its clinical path happens to be.
It is still diversified. That’s essential in an industry where hundreds of stocks are still in bear market territory, despite all the vaccine buzz taking scattered winners into the stratosphere.
Both XBI and IBB ensure that everyone got a taste of the winners. Nobody missed out on MRNA or gambled everything on a clinical trial that failed.
The difference is in how the portfolios are constructed. IBB relies on inertia. As companies grow, their weight in the index grows too, which means the index today reflects their past success.
XBI is all about the future. The scoreboard resets every three months. Every constituent is an equal member of the team. When the team does well, we all cheer.
That’s the kind of thinking driving my newsletters these days. If you’re already an IPO Edge subscriber, you’ve seen it in action with our talk about paper profit levels and when to let triple-digit-percentage wins ride.
Anyone can pick stocks. Very few people have a talent for doing it consistently. And when you can overlay additional discipline across the stocks you pick, the gains stack a whole lot faster.
I’m excited about the future. Whatever happens in the market, the economy or Washington, we’re where we need to be.
All we need to do is define the parameters and then give the system time to work. We have time. Just to draw a few examples from the biotech world, we’ve been in some of the hottest holdings in either XBI or IBB for years.
I got a few Turbo Trader subscribers into Arrowhead Pharmaceuticals Inc. (NASDAQ:ARWR) below $7. That was obviously a few years back, but a well-designed portfolio is about patience as well as insight.
CANNABIS CORNER: Is Aurora Doomed?
While it has been a great month for cannabis stocks, long-term shareholders are still staring at big lifetime losses and bigger questions.
At this stage, decriminalizing cannabis nationally, or even internationally, isn’t going to change the math driving cultivators like Aurora Cannabis Inc. (NYSE:ACB) and Tilray Corp. (NASDAQ:TLRY).
They’re selling as much dried plant matter as they can. They’re charging what the market will bear. But they just aren’t making money at this scale.
And for various reasons, demand isn’t growing as fast as it did when the recreational market first opened up. Early adopters across North America are already regular customers and their consumption is built into corporate revenue.
That’s not the growth proposition that gave these stocks so much blue-sky buzz when the boom was new. Cannabis investors now see a more sober landscape dominated by business considerations: profit margins, cash flow and balance sheets.
On that level, most of the group seems to have recovered Wall Street’s confidence. Refined business models like the ones that drive Green Thumb Industries Inc. (OTC:GTBIF) and GrowGeneration Corp. (NASDAQ:GRWG) are on track to beat just about everything on the market this year.
Even stocks on the pot periphery like Scotts Miracle-Gro Co. (NYSE:SMG) are beating Silicon Valley giants like Apple Corp. (NASDAQ:AAPL) and Amazon.com Inc. (NASDAQ:AMZN).
But TLRY, and especially ACB, remain under a heavy cloud that a good month hasn’t overcome. In theory, TLRY has a happier ending. Management promises that quarterly losses will end this quarter.
That’s a bit of a surprise. Wall Street still projects that the company will burn about $375 million before finally achieving profitability in 2023. With $155 million in cash and a total of $304 million in current assets, that’s a road to oblivion.
If TLRY starts making money, its long-term survival odds will improve dramatically. Otherwise, the stock will mostly attract speculators.
ACB, on the other hand, is actively selling stock to extend its timeline. While the company has $420 million in assets on the balance sheet, only $162 million of it is in cash. Consensus expects a $245 million burn between now and a potential profit point four years away.
That’s a long time to wait for clarity that the business model actually works. And, while a recently announced $500 million stock sale will keep the company liquid, we’ve already seen a lot of dilution here.
ACB has already expanded its share count from 47 million in 2018 to 115 million today. The next sale looks like it will take the float beyond 165 million shares, quadruple where it was two years ago.
Meanwhile, the stock has crashed, which means that investors are chasing four times as many ACB shares as they were in 2018 at no more than 1/6 the price.
If demand for ACB had kept up with supply, there would be no problem. But as it is, there are too many shares and not enough cash flowing through the company to hold up the price.