Eli Lilly Stock Heads The Wrong Way

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What should you do when a favorite stock goes the wrong way?

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Eli Lilly is down 2.8% since Wayne Himelsein, my top quant manager, last recommended it. All investors, even the great ones often find that the market does not quickly come around to their way of thinking after they buy a stock. Developing a consistent thought process for these situations is one of the keys to a successful investment discipline. Here’s how Wayne makes these decisions.

Ken Kam: Wayne, before we talk about any new stocks this week, I’d like to talk about Eli Lilly which has not performed as you expected.

Wayne Himelsein: Eli Lilly is not performing up to my expectations. I’d like to discuss some key principles of my investing approach in relation to some prior picks, and in doing so, construct recommendations along those lines for both a new pick and the priors.

Kam: I am curious to hear about your key principles and interested to hear your new pick.

Himelsein: Thanks, Ken. One of the key principles of money management is that picking the right stocks is just the beginning of the battle.

Showing up to the battlefield with the sharpest sharpshooters from the Navy Seals, and the best weapon technology that our military has to offer is a fantastic starting point, but if the generals do not deploy their firepower with the right strategy, they risk losing.

On the battlefield, strategy, to a large extent, supersedes firepower. With investing, picking a good stock is just the start. Managing from that moment forward is the strategy.

Kam: I could not agree with you more. I have seen many a good stock picker identify a great buy, but then sell too soon, or watch something significant change, and see their pick reverse all their profits back to nothing. So what wisdom can you share for strategic investing?

Himelsein: I want to start with two of my picks as of recent, Eli Lilly, from our April 7th discussion, and Starbucks, from our March 9th talk. Since identifying those, Starbucks has gained a tad over 10%, i.e. gone well, and Eli Lilly has lost about 2.8%, i.e. gone not so well. This is a beautiful case study of 1) a stock going right, and 2) a stock going wrong; literally, the two polar possibilities.

Concurrently, I want to throw out a new stock for today, Xilinx, not because I particularly love it right at this moment, but because I already own it in my portfolio, and it fits nicely into the core principles of money management I am addressing; both of which come together for sound reasoning to get into the stock now or anytime soon.

Kam: Okay, so you’re discussing three different stocks today, all that fit into the key ideas you’re trying to share. Are you recommending all three?

Himelsein: Not exactly. And I’d love to explain why. Let’s start with the prior picks of Eli Lilly and Starbucks and the idea of staying with your “rights” more than your “wrongs.”

I was far more right with Starbucks. I picked it, and it outperformed the market. Therefore, what I thought was true, aka my thesis, is proving itself right. Accordingly, it has provided credibility, and so I stay with it.

On the other side of the coin is Eli Lilly. It had a negative outcome, so the thesis argument swings the other way. It did not do as expected, so it lost credibility. It is not as wonderful as I believed it to be three weeks ago. But is that enough time to “disprove” its worth, to lose its credibility?

With Eli Lilly, that’s a tough call, because I talked about how “independent” it was behaving. I didn’t expect it to move with the market, I liked it for its defensive nature; so has it actually disappointed?

Kam: I recall you saying you specifically liked Eli Lilly because it does not move with the market and that it might be one to hold up better if the market turns down. So how do you decide what to do?

Himelsein: The beautiful answer is that decisions like these fall into one simple idea — sizing; which is a core principle of portfolio management that makes or breaks investing. That is, adding to or subtracting from your position relative to how much it is “respecting” your original thesis for entering. Whether your thesis was technical or fundamental, self-driven, or recommended, the degree to which it maintains credibility is how one should re-size the bet on a go forward basis.

Stepping away from those two picks for a moment, I’ll move on to my new pick for today, Xilinx. As mentioned, and though I haven’t brought it up before, it is already in my portfolio (to be clear, every name I ever talk about is in my portfolio, there are just more names in my portfolio than times available to share, so I select my favorites to discuss). Xilinx has not only done beautifully, up about 4.25% for April, but with the smooth and consistent daily growth that screams strength.

With that in mind, as of today, I’d be comfortable buying more Xilinx, and therefore, equally so, I’m comfortable recommending it today to anyone who has no position at all, as that is, on a relative basis, just sizing up from zero.

Kam: I see what you are saying. The point is that in managing a portfolio, it is not necessarily a decision of what to do with Eli Lilly on its own, but how to handle it given other opportunities. Am I thinking about this correctly?

Himelsein: That is exactly the point. Going back to Eli Lilly and Starbucks, given we all have a finite amount of capital, we now have a group decision to make. Eli Lilly has not done as hoped, Starbucks certainly has, so it makes sense to take some money out of Eli Lilly, i.e. downsize, and add it to Starbucks. Move capital from lowered credibility to increased credibility.

But then Xilinx shows up. Well, don’t reduce Starbucks, as that’s the winner whose been proving itself, which you have just increased with some capital from a bite you took out of Eli Lilly. So once again, downsize Lilly, your loser, take that free capital, and buy a small piece of Xilinx.

After all this maneuvering, you might have a smaller than average position in Xilinx and Lilly, and a larger than average position in Starbucks. Point is, you are a managing a portfolio. Not all stocks are equal, and so not all stocks deserve the same amount of capital.

Kam: That makes total sense. But something that I’m still wondering is why Lilly has been dubbed the “loser” when you specifically chose it for its counter market behavior?

Himelsein: You are right, and that’s a good question. The answer is that because we just never know, the safer thing to do is to re-size.

I still actually like Eli Lilly for the very same reasons I discussed on April 7th. But, and this is a big but, I don’t like how much it has retracted. I noticed some news about Bernie Sanders “medical care for all” plan that is bothering the healthcare sector. I am not well read on the nuances of it, nor is it worth my time to delve deeply — that’s just not what I do.

What I do know is that Eli Lilly has been smacked more than I expected it would, to the point of slightly adjusting the strength of my thesis. Perhaps if the news dissipates, or does not do the damage that some are anticipating, Eli Lilly goes on to become the greatest stock that ever lived. But because we just cannot watch and know everything about everything, the safe answer is to downsize the risk and move the capital to our credible friends — Starbucks and Xilinx.

My Take: When a favorite stock falls, many investors are tempted to buy more shares figuring they are an even better deal. Value investors are particularly prone to this. Other investors are quick to sell while the losses are still small. Both approaches can work when applied consistently and judged over the long-term.

Wayne Himelsein’s Logica Focus Fund (LFF) has an 18+ year track record that extends through 2 market crashes, numerous corrections, and sector rotations. Over that period, Wayne’s model averaged 11.99% a year which compares well to the S&P 500’s 5.94% return for the same period.

To be notified when Wayne updates his views, click here. To be notified when I write about specific stocks my top analysts cover click here.

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