What's the source of your investment strategy? Many look to great investors like Warren Buffett for guidance on how to invest. Some take what we at the Fool call a "motley approach" and try a little bit of everything. Others really don't have an investment strategy at all. They just throw their money at whatever looks good at the time.
Here's another angle: Learn from successful companies. In other words, see what made a given company do well in the market and find others that exhibit similar attributes. There are plenty of companies to choose from, but let's see how this approach plays out with an example from the biotech world: Vertex Pharmaceuticals (NASDAQ: VRTX ) . Here are three investment strategy lessons from Vertex's success.
1. Understand the market opportunity.
Even the best-run company in the world won't produce stellar returns if it operates in a sector with lackluster sales potential. Before buying a stock, make sure you understand the market opportunity. Look at the realistic potential for sales and the strength of competitors. If all looks good, the stock can advance to your next stage of analysis.
For example, a key market targeted by Vertex is cystic fibrosis. The disease impacts around 30,000 Americans and has no cure. While treatments exist to address some symptoms, no drug targeted the defective protein at the root of cystic fibrosis -- until Vertex introduced Kalydeco.
Some analysts project that Kalydeco should reach annual sales of more than $1 billion within the next three years. Vertex's other cystic fibrosis drugs in development could triple that amount.
Of course, developing a product for a market with great opportunity doesn't guarantee success for your investment strategy. An estimated 1 million people die each year from complications related to hepatitis B. Dynavax (NASDAQ: DVAX ) developed a hep-B vaccine, Heplisav, that showed tremendous promise. However, safety concerns derailed approval for the drug. While Heplisav might still reach the market, Dynavax's experience highlights the risks even in a market with solid potential.
2. Be patient.
Success doesn't typically happen immediately. Investors usually must be patient and wait for good things to happen. Sometimes, that waiting means persevering through tough times.
Shareholders of Vertex experienced this challenge in the fourth quarter of 2012. The stock plunged 34% starting in October after it reported clinical results for experimental cystic fibrosis drug VX-809 followed by disappointing quarterly sales numbers. However, any concerns were temporary. Patient investors can now claim gains of nearly 30% above the early October levels.
MannKind (NASDAQ: MNKD ) could probably serve as the poster child for investor patience. The company is now on its third attempt to gain regulatory approval for its inhalable insulin product, Afrezza. MannKind, though, has a management team that believes in its vision and has forged ahead through trying circumstances. Shareholders who remained patient through the years could finally see their investment pay off later this year when the Food and Drug Administration makes a decision on Afrezza.
3. Know that business dynamics can change.
While patience is essential, it is equally important to understand that underlying business dynamics can change. These changes often impact the attractiveness of the stock.
Vertex provides a good example of this lesson also. When the company launched hepatitis C drug Incivek in 2011, everything looked up. Analysts predicted peak annual sales of $5 billion. But things changed.
Revenue for Incivek was $1.16 billion in 2012, but sales are now declining. Other drugmakers developed new products that are better.
Gilead Sciences (NASDAQ: GILD ) , in particular, appears to be in the lead for developing an all-oral combination for hepatitis C. The biotech recently reported results from a study where patients in one arm were clear of hep C after only eight weeks of taking its drug combo. This doesn't mean that Vertex can't catch up with Gilead (and the biotech's cystic fibrosis opportunities still make the stock attractive), but it illustrates how quickly business dynamics can shift.
Another prime case study for this comes from Spectrum Pharmaceuticals (NASDAQ: SPPI ) . Spectrum's stock more than doubled from October 2011 through July 2012. However, shares plunged 55% from those highs because business dynamics changed since then. A shortage of a generic rival to Spectrum's lead drug Fusilev was alleviated, resulting in sales slowing down considerably.
Of course, three lessons from one biotech doesn't necessarily add up to a successful investment strategy. But it's a start.
Look at other companies that have done well. For that matter, also examine those that have failed. Identify the reasons behind victories and defeats. Learning the right lessons from the right sources and applying those lessons should lead to developing a solid investment strategy over time. Warren Buffett didn't begin with all the answers, either.
Even knowing the answers doesn't always help. The price of becoming the world's greatest investor is that Warren Buffett can no longer make many of types of investments that made him rich in the first place. Find out about one such opportunity in "The Stock Buffett Wishes He Could Buy." The free report details a sector of the economy Buffett's heavily invested in right now and exactly why he can't buy one attractive company in that sector. Click here to keep reading.