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The One Question You Need to Ask

By Dr. George Huang
Friday, December 5, 2008

Every year, I meet with at least 50 companies to find the best opportunities for my readers. This year, I've logged more than 100,000 miles, visiting companies headquartered in the U.S., Asia, South America, and Europe. I've also attended endless investment conferences, where I see as many as 15 companies a day.
 
At these meetings, companies try to feed you the rosiest possible scenarios. Just like every Internet company believes it's the next eBay, every biotech thinks its drugs will be the next big thing. Sorting "corporate speak" from the truth is a difficult task.
 
But there's one question that helps me cut through the "bull"...
I stole this question from famous mutual-fund manager Peter Lynch. Lynch has said he first learned about many of his great investments by asking this question.
 
The question I ask every CEO I meet is: What other companies do you most admire?
 
Many biotech CEOs idolize Genentech. After all, Genentech is a pioneer in the field. The company has returned early investors over 30 times their money since 1988. Most CEOs dream their companies will become the next Genentech.
 
On the other hand, none of the CEOs I've spoken with has ever confessed to admiring the big pharmaceutical companies – Pfizer, Merck, Bristol-Myers, or Eli Lilly, for example.
 
That's unsurprising. After all, Big Pharma management has turned these once-innovative companies into marketing firms. They focus less on saving lives and more on selling life-style drugs like Viagra. And executives have paid themselves millions in compensation while ignoring shareholder interests.
 
(It hasn't gone unnoticed. The five pharmas I mentioned above are down an average 50% over the last decade.)
 
But one pharma-like company has collected quite a few admirers: generic maker Teva Pharmaceuticals (TEVA). One CEO went even further, saying, "Teva has the best management team of any company in health care."
 
Teva is the largest and most profitable generics maker in the world. Sales will top $11 billion this year. Market forces are on its side, too. Drugs with $200 billion in sales will lose patent protection in the next five years. I expect Teva sales to top $20 billion in four years.
 
After its $7.5 billion acquisition of Barr, the fourth-largest generics maker in the world, Teva will become even more dominant. The company's enormous scale and global operations enable it to generate huge returns on capital. For every dollar in revenue, more than 20 cents fall to the bottom line after deducting all expenses. That's incredible in the cutthroat, low-margin generics business. And this year, Teva should generate $2.5 billion in free cash flow.
 
Long-term Teva shareholders are up huge. The stock has returned about 1,000% in the last decade, or 26% per year.
 
With a market cap of $35 billion, the stock is trading for only about 14 times free cash flow. For the best-run company in the rapidly growing generics business, 20 times cash flow is more appropriate. So even after that monstrous run, Teva stock is cheap.
 
When you ask a CEO who he admires, you're likely to get insight into his business you won't find in any press release. More importantly, you'll occasionally pick up a great investment idea...
 
Biotech leaders admire Teva because of its incredible operational efficiency and smart acquisitions. I agree. And at these prices, you should put Teva in your portfolio and not look at it again for five years. You will be glad you did.
 
Good investing,
 
George




Market Notes
Oil drops below $45, natural gas below $5... Oil, natural gas, and gasoline funds all hit new lows.
 
Infrastructure company Granite Construction hits new high... up 29% this year.
 
Automotive and marine technician school Universal Technical Institute hits 52-week high.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1224.71 +0.3% +11.4%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.19 -0.6% +7.2%
Euro 1.34 +1.4% -11.0%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
Change
52-Wk
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%

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