I love biotechnology, and I'm not ashamed to admit it. Our ever-increasing ability to tinker with the "stuff" of life itself is exhilarating, humbling, thought-provoking, and sometimes even frightening. The promise of new medicines, better health, more nutritious and plentiful foods, space-age diagnostics, and other life-improving innovations appeals to my utopian side.
Then there are the investment returns -- and few things pay off like the biotech home run. Sure, Celera (NYSE: CRA ) increasing 700% in two months and then coming all the way back down is a freak event, but most of today's prominent biotechs rose 20-fold or more in just a few years.
Don't be afraid
For all that promise, biotechnology has a certain mystique. It's presumed to be a field where only "experts" should tread. Many avid investors willing to dabble in retail or technology or real estate avoid biotech altogether. In a recent interview with Fool co-founder David Gardner, entrepreneur and NBA owner Mark Cuban said he avoids the sector: "I try to make sure I know what I know and know what I don't know, and biotech and nanotechnologies are things that I just don't know."
Avoiding an industry you know nothing about or have no interest in is good advice. But with a little diligence and some guidance, biotech investing isn't daunting. Yes, it pays (literally) to have an acquaintance with the science, but you don't need a Ph.D. or an M.D. for big returns. In fact, the best returns on biotech investments tend to accrue after the scientific questions have already been answered. Sure, you may lose some gains by buying a stock after a successful phase 3 trial or a product approval, but if the company is a winner, you can show up late and still enjoy the lion's share of the rewards.
To find and profit from biotech's multibaggers, follow three tips for lower risks and higher rewards.
1. Arrive fashionably late
Consider Gilead Sciences (Nasdaq: GILD ) , a biotech blue chip that went public in January 1992 at a split-adjusted $2.16 per share. Over its first eight years as a public company, the stock rose to $7.14. Investors who got in at the IPO and sold in January 2000 enjoyed a compound annual growth rate (CAGR) of 16%. Not bad, you might say -- but the S&P 500 rose 352% over the same period, for a CAGR of 17%.
What about folks who bought those same shares at the beginning of 2000 and still hold them today? Those investors have been rewarded with three stock splits. Gilead's stock price has increased from an adjusted $7.14 to more than $42 per share today -- that's a six-bagger in just five years, with a CAGR of 38%. Over the same period, the S&P 500 lost 17%. Gilead has been a smoking investment . but only for investors who arrived fashionably late to the party.
What changed in 2000? Well, the entire biotech sector skyrocketed between 1999 and 2000, and most companies in the industry enjoyed stellar gains -- for a while. When biotechs sank like a stone from 2001 to 2003, Gilead kept rising. It was driven by something different: In the first part of 2000, Gilead began phase 3 clinical trials of what would become two of its most important products, Viread (for HIV infection) and Hepsera (for hepatitis B). Those products were approved in 2001 and 2002, respectively.
Gilead had a few approved products before then, but the new products then nearing the market represented the company's first significant revenue opportunities. Waiting until the writing was on the wall lost investors very little -- and left them with plenty to gain.
2. Focus, focus, focus
Another important change that took place in 2000 was that Gilead narrowed its focus to antivirals. Over the previous eight years, it dabbled in cancer drugs, antisense, antibiotics, and aptamers, as well as antivirals. That lack of focus turned off investors, even though Gilead had some incredible technology outside of its core franchise. The company's aptamer assets ultimately became the intellectual property backbone of Archemix and SomaLogic, two privately held companies. Its oncology portfolio went to OSI Pharmaceuticals (Nasdaq: OSIP ) ; OSI-7904L is now in phase 2 for gastric cancer. Gilead spun out the age-related macular degeneration drug Macugen to Eyetech (Nasdaq: EYET ) . Their antisense assets became Sigma-Aldrich's (Nasdaq: SIAL ) Proligo nucleic acid chemistry division.
While a diligent science nerd may have invested early based on the promise of these assets, the market didn't much care. What ultimately moved the stock was not cool science but a concentration on near-term products that the company could sell to a manageable audience of physician specialists and hospitals. When Gilead focused, its stock rocketed.
3. It's the market that counts
For a Big Pharma, a new blockbuster drug can help management achieve the growth that shareholders have come to expect and keep dividend payments on track. For a small biotech, a single successful product can be utterly transforming. When Scios didn't receive FDA approval for its heart failure drug Natrecor in 2000, the stock plummeted to around $3, representing a market cap of about $115 million. Less than three years later, new trials were conducted, the product was approved, and the company was acquired by Johnson & Johnson (NYSE: JNJ ) for $2.4 billion -- a more than 20-fold increase in market cap. Just by waiting for Natrecor's approval, more risk-averse investors could have scored a cool triple.
The non-Hodgkin's lymphoma drug Rituxan is almost solely responsible for transforming Idec Pharmaceuticals from a split-adjusted $6 in November 1997, when it was first approved, to $40 per share when its merger with Biogen to form BiogenIdec (Nasdaq: BIIB ) was announced in June 2003. If you'd bought into Idec's September 1991 IPO, your shares doubled over the six years it took to get Rituxan to market. Over the next six years, those shares went up almost sevenfold.
The list goes on: Celgene and Thalomid, ImClone (Nasdaq: IMCL ) and Erbitux, Onyx Pharmaceuticals and Sorafenib, and many more. I'm not suggesting that you should bet everything on a single drug. Rather, the message is that these drugs produced great returns for shareholders because they addressed substantial markets, and their impact on stock prices was felt after there was already plenty of clinical evidence that they worked.
What you can do now
Are these opportunities always easy to see? Absolutely not. But when it comes to biotech investing, you're better off studying market opportunities than signal transduction pathways. And happily, that kind of research will come easier to most investors.
With some diligence, you can ride your high school biology to biotech investing success. The bad news, unfortunately, is that picking winners is still a hit-and-miss affair. But it doesn't take too many 20-baggers to make up for a few duds. In our Motley Fool Rule Breakers newsletter service, we scour the public markets for the rising stars. Our portfolio already includes some of the very companies I think are in the early stages of transforming into multibaggers. If you'd like to kick the wheels on a free 30-day trial to our service, you'll get two stock picks per month and full access to our write-ups on all 20 of our picks to date. There is no obligation to subscribe, so if you don't like the service, cancel without paying a dime. Click here to learn more.
Karl Thiel does not own any stocks mentioned in this article. Biogen Idec is a Motley Fool Stock Advisor recommendation. The Motley Fool has adisclosure policy.