Case 024Stock pitch and thesis defenceCore
In a risk interview, pitch a pharma stock risk first: 45% of revenue from US generics, one plant under regulatory observation, a downside of minus 35% at 30% probability and an upside of plus 40% at 70%. What is the expected return, and how large a position does it justify?
1The situation
Mahuli Pharma has revenue of Rs 8,000 crore, 45% of it from generic drugs sold in the United States. Its largest plant, which makes about 40% of those US products, has received observations from the US regulator after an inspection, and a follow-up visit is due within six months.
Your work gives two outcomes over a year. If the plant is cleared and the pending launches go ahead, the stock returns plus 40%; you put that at 70%. If the plant is barred from the US market, the stock returns minus 35%; you put that at 30%. The fund's rule is that no single stock's downside case may cost more than 1% of the fund.
2Your task
Pitch Mahuli risk first: what can go wrong and how much, what is the expected return, and how big a position does it justify?
Quick check
What is Mahuli's expected return on your scenarios?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Expected return is about 17.5%, enough to own it, and the 35% downside, not the upside, sets the size: about 2.9% of the fund. The risk is one plant supplying about Rs 1,440 crore of US sales. The idea keeps a positive expected return unless the chance of a US bar exceeds 53%. With a 1% loss budget and a 35% fall, the position is 1 divided by 35, about 2.9%, reviewed when the regulator's follow-up visit reports.
Step 1Why pitch the risk first?
Because a risk team's first question about any idea is what it can cost the fund, and a pitch that opens with the upside makes them dig for the downside themselves. Lead with the one event that can break the thesis, its size and its probability; then the expected return; then the position size those two imply. A mountaineer plans the descent before the climb for the same reason: the summit is optional, getting down is not.
Step 2What can go wrong, and how much?
Size the exposure from the facts. US generics are 45% of Rs 8,000 crore, Rs 3,600 crore, and the plant under observation makes about 40% of those, so roughly Rs 1,440 crore of revenue, 18% of the total and usually a higher-margin share, sits behind one regulatory decision. If the plant is barred, those sales stop until it is re-inspected, often more than a year, and the market re-rates the whole business for the risk that other plants follow. That is the minus 35%.
Step 3What is the expected return, and how robust is it?
Probability-weight the outcomes: 0.7 times 40% plus 0.3 times minus 35% is 17.5%. Then ask how wrong your probability can be. The expected return falls to zero when the chance of a bar reaches 40 divided by 75, 53.3%. Your estimate of 30% can be wrong by more than 20 points before the idea stops working, which is the kind of margin a risk team wants to hear stated.
Step 4How large a position does that justify?
Size from the downside, not the upside. If the downside case may cost the fund at most 1%, the position is 1% divided by 35%, about 2.9% of the fund. It is tempting to reach for the Kelly criterionA formula for the bet size that maximises long-run growth given known odds. With estimated odds it recommends far too much., but on these inputs it recommends 125% of the fund, which shows why no one uses it with estimated probabilities. Then add the portfolio view: if the fund already holds other US generic makers exposed to the same regulator, the combined downside, not Mahuli's alone, must fit the budget.
| Sizing rule | Working | Position |
|---|---|---|
| Loss budget of 1% on the downside case | 1% / 35% | 2.9% |
| Kelly, full | 0.7 / 0.35 - 0.3 / 0.40 | 125% |
| Kelly, half | half of the above | 62% |
Close with the monitoring plan. The follow-up inspection is a dated event, so write down now what you will do on each outcome: add towards a full position on clearance, exit on a bar rather than wait for a rebound. A risk-first pitch ends with the exit rule, because that is what makes the downside number real.
Where candidates lose it
Candidates pitch the upside, then treat the downside as a footnote. In a risk interview the size and probability of the downside are the pitch, and the position size should be derived from them.
The second loss is averaging the two outcomes, 40 and minus 35, to get 2.5% or 5%. Probabilities matter; the weighted answer is 17.5%.
What the interviewer asks next
- The fund also holds two other US generic makers. How does that change the position size?
- What evidence from the follow-up inspection would make you raise the downside probability to 50%?
- How would an options position change the shape of this bet?
Asked at Franklin Templeton, Risk Management, San Mateo, 2017 (Wall Street Oasis): the difference between actively managed and passively managed mutual funds. Pitch me a stock.
Company names and figures are illustrative.