Obvious Is Not Always True

Investing looks to the future. Looking to the past, even the very recent past, can be misleading.

I first noticed this a few months ago when I listened to people tell me the wonder of large pharma companies and how they could become another Apple. At the time, I was not impressed, maybe because I was fed up with the vaccine propaganda that seemed to be everywhere.

One thing I have learned, albeit slowly, is that sometimes I am wrong.

To that end, I decided to take a look at the pharma idea again.

The discovery

I started with the pharmaceutical industry and the idea of competitive advantage, cost leadership, and the cost to grow. I fairly early on discovered Eroom’s Law. It was more than a little disturbing on two fronts. Its effect on investment and its restriction on the development of worthwhile pharmaceuticals.

Eroom’s law arises from observation and perhaps is not rigid. It points out that the cost to deliver a new drug has doubled every nine years since 1950. That’s eight doubles to now. Eight doubles are 256 times. Amazing what 8% a year yields over a long time. Maybe having more time to invest matters more than the yield, but I digress.

I did not look a lot further. Businesses with diminishing marginal utility of capital are automatically unattractive. Free cash flow is where the value lies, and if the cost of sustaining the business rises that quickly, free cash flow will be restricted.

A comparison

There is a similar law named after Gordon Moore in the semiconductor industry. He observed that since 1965 the number of transistors on a semiconductor device has doubled every two years. Some say 30 months. The cost per transistor has fallen to near zero in the process. In this industry, product value per dollar is improving. I like that better.

You might notice that Eroom is Moore spelled backwards, which is the general idea of the comparison. Pharma is governed by a rule opposite Moore’s Law. Should I invest in Intel? Maybe, but you would need more information to answer.

The conclusion.

While I prefer Big Pharma to be working on whatever I might need 20 years from now, I think they will need to do it without capital investment from me. At the current cost of time and money to develop a new wonder drug (12 to 15 years and $2.5 billion to get a drug from the lab to the pharmacy shelf,) they will not be able to develop all the molecules that have potential. Not quite what one would want for a superstar investment choice. Capital-bound is a blemish.

To add to the complexity of this comparison is the need for exotic materials in the semiconductor industry. For example, did you know Neon is a crucial material for making a chip? I didn’t either. Did you know Russia and Ukraine together supply 70% of the world’s Neon? Oops. I think there will be a supply problem and it isn’t like the chip makers are free of problems to start. Be cautious.

Moore’s law may slow down some, but I don’t see Pharma catching up. Maybe if they find a side-effect-free drug to help people cope with anxiety! But then there is the 12-year lag.

The bits to take away

It does not take a lot of digging to get a general sense of a stock’s viability.

Sometimes it is not what you first think.


I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.

Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.

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