One of the best performing stocks in our portfolio over the last couple years just gave away 50% of its peak gains about three weeks ago, after the Food & Drug Administration (FDA) issued a warning letter asking the company to address a few concerns it had about the company’s medical device it has been selling for well over a decade. Still, one of the company’s biggest institutional investors working closely with the company on strategic decisions has quietly disclosed that it just added to its position, giving us some degree of confidence that this seemingly negative development is a small bump in the road. This little known home healthcare company has grown 34 of the last 36 quarters and in our opinion was just on the brink of reaching an inflection point in growth.
Medical devices can be marketed as Class I, II, or III. Class II and III Healthcare companies that want to market medical products may have to attain clearance from the FDA in one of these three classes. The FDA letter raised concerns that some investors took to mean that the target company would have to apply for a higher clearance standard.
Company To Come Out Unscathed From FDA Warning?
This would require the company to spend tons of capital to resubmit approval for its flagship product. The target company has responded to the FDA letter and we believe there is a reasonable probability it will come out of this development unscathed for the following reasons:
- The additional purchase of stock by the institutional investor adds a degree of confidence.
- A lax in reporting protocol to the FDA that appeared to play a big role in the issuance of the FDA letter is being addressed.
- We believe that the company is the leader in its field and appears to have much safer and more effective products than its competitors.
- It looks like its most relevant competitor has an inferior product and has not received a warning letter.
- The company is still receiving indications of interest from new customers, such as the Military, who are aware of the FDA warning letter.
Opportunity Amid Catastrophe
A big challenge of investing in stocks is that it can take several quarters of company progress before the market will reward shares, only to see them be driven down on the hint of one piece of negative news. Your goal is to find the diamonds in the rough that have pulled back due to negative news that will not impact overall growth prospects.
Not all of these chances pay off big, but when they do the returns can often be outsized and worth the risk, especially when a stock has been so beaten up. We have made our bet.