Anatomy of a Multibagger: Vertex Pharmaceuticals

We're back to examine the three stocks in the Motley Fool Rule Breakers portfolio that have more than doubled in the two short years of the service.

Last week, we looked under the hood of NYSE Group, our best performer to date. Today, our subject is Vertex Pharmaceuticals (Nasdaq: VRTX), which biotech analyst Charly Travers selected for the February 2005 issue; it is up more than 235% since then.

Why Charly bought
When Vertex joined the portfolio, it had been a steady underperformer, having fallen more than 80% from its highs in 2000. Skepticism plagued the stock like a head cold in sub-zero temperatures. In the initial buy report, Charly seemed a lonely voice in arguing that the pessimism was overdone:

"I think given the pedigree of its founders, the company has been a victim of unrealistic expectations. Many investors have a short attention span and forget that even with top-notch science, drug development takes a very long time. I am recommending Vertex as a Rule Breaker because the company's internally developed drugs are exciting and on the verge of raising the company to the industry's top tier."

Charly was referring specifically to a drug called VX-950, which was developed as a protease inhibitor in the same fashion as some of the more successful HIV treatments available. But this wasn't another AIDS cure. VX-950 was instead aimed at hepatitis C (HCV), a blood-borne virus that continues to be the leading cause for liver transplants in the United States. Vertex was working on important science, Charly argued.

Maybe so, but dozens of earlier biotechs had gone broke working on important cures. Vertex had to be different. It was, Charly argued, because of licensing and R&D deals already in place. Take GlaxoSmithKline (NYSE: GSK), which was already promoting two of Vertex's drugs for HIV. Meanwhile, Merck (NYSE: MRK) and Novartis (NYSE: NVS) were offering needed R&D help.

By May 2005, Vertex had announced very promising clinical data for VX-950, and our recommendation was quickly up 34%. By November, the stock had doubled, allowing Vertex to trade in oppressive debt by giving creditors an ownership stake.

Why he still holds
Fast-forward to today. VX-950 is now known as telaprevir and is performing as expected in phase 2 clinical trials -- though that wasn't enough for investors. What was a four-bagger in November is now back to being a three-bagger. Is Charly worried? Hardly.

"Since HCV is a huge market, telaprevir is going to be a blockbuster drug," Charly told me. "Just because Vertex has been a three-bagger for us does not mean we should jump off this train. There's a lot more money to be made owning this stock, at least until telaprevir nears the FDA approval process."

Find your multibagger
Want to bet that Charly is wrong? I wouldn't. He's an expert at finding the biotechs that are most closely aligned with the medical needs of the moment. That's what Vertex was and still is -- and investors are reaping the rewards of his research.

As you embark on your own quest for the next big biotech winner, remember the lessons of Vertex. Don't just speculate. Instead, seek leaders with obvious and identifiable advantages and the capital to exploit them effectively. Those are the firms that transform thousands into millions.

See you back here next week for a look at our other multibagger. Or, if you'd rather not wait, click here to get 30 days of free access to the entire Rule Breakers portfolio right now.

Fool contributor Tim Beyers only breaks the rules in his portfolio. Wimp. Tim didn't own shares in any of the companies mentioned in this article at the time of publication. Get the skinny on all of the stocks in Tim's portfolio by checking his Fool profile. GlaxoSmithKline is a Motley Fool Income Investor pick. Merck was formerly an Income Investor pick. The Motley Fool's disclosure policy is a rebel on Wall Street.