Carburton Street, London -- Roach watchers were out in force today. For those who are unfamiliar with this rather quaint analytical technique, here is a quick précis. The theory asserts that if you see one cockroach, then there are probably a whole lot more around. And just because you haven't seen them yet, it doesn't mean they're not there. In terms of the stock market, it means that if one piece of bad news leaks out then there is a high probability that more bad news could be just around the corner. Or alternatively, if one sector is in trouble then other players in the sector could be in deep doo-doo as well.
Last night on Wall Street, Merck (LSE: MRK), the second biggest drug maker in the US, told the market that earnings in 2002 would come in at similar levels to this year. In other words no earnings growth guys, sorry! The forecast worried Wall Street and drug-related issues went into decline. London braced itself early on and as sure as eggs are eggs, pharmaceutical shares were marked down sharply in early trading. Amongst those to make a retreat included GlaxoSmithKline (LSE: GSK), AstraZeneca (LSE: AZN) and Shire Pharmaceuticals (LSE: SHP).
Merck's woes, if you can call it that, were caused by patents on some of its key medicines that will soon expire. Patents afford a drug company exclusive marketing rights but once those patents expire, it is a free for all and generic drug makers can then step in to produce cheaper version of the same medicine. There are also worries that sales of some of Merck's other drugs may be slowing down.
The decline in Merck's share price now brings its forward price to earnings valuation down to 20, which looks ostensibly cheap for the long-term investor. But more importantly, the company expects to return to double-digit growth in 2003 when earnings will start to perform in line with the rest of the sector.
I am not a great fan of the Cockroach Theory but appreciative, at times, when it is applied indiscriminately by traders. The mass exodus from the drug sector can present unexpected opportunities for the long-term investor who is prepared to scour the sector for arbitrary sell-off. This can present good opportunities for those who are prepared to take advantage of what can only be described, in this case, as illogical trading.
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