Start Making $79,000 Today

Invest only in biotech stocks.

Sound crazy? Maybe, but that's what I do. I'm not fazed by their high risk or jaw-dropping volatility. That's because when biotech winners hit, they hit big. Simply put: A basket of carefully selected biotech stocks will trounce the market over the long haul.

The ultimate growth industry
Health care is a sector with a massive demographic tailwind, as baby boomers age and spending skyrockets on drugs and medical devices.

Many major advances are coming from small-cap biotechs. Thanks to their small size, a single drug can drive tremendous increases in value for a company like this. The lengthy and expensive clinical trials required to earn FDA approval serve as a steep barrier to entry, allowing companies that cross this milestone to maintain fat profit margins for many years.

These factors combine to give us an opportunity to latch onto explosive returns.

Growth investors can't afford to ignore biotech
The top-performing U.S. and Canadian biotechs over the past five years have an average return of 694%. A $10,000 investment in this basket would be worth $79,400 today:

Company

Return, Feb. 2003 to Feb. 2008

Celgene

929%

Meridian Bioscience (NASDAQ:VIVO)

887%

Onyx Pharmaceuticals (NASDAQ:ONXX)

843%

Ventana Medical Systems

821%

Immucor

711%

Savient Pharmaceuticals (NASDAQ:SVNT)

684%

Elan (NYSE:ELN)

552%

Cepheid

544%

Alexion Pharmaceuticals

496%

United Therapeutics

471%

Source: Capital IQ, a division of Standard and Poor's. Results exclude penny stocks.

But looking at past performance alone does nothing to help us make money now. We need to understand exactly what was creating these monstrous gains if we hope to replicate that performance over the next five years.

To help address that issue, I looked for a defining characteristic that drives the performance of these small-cap biotech companies.

That defining characteristic
As it turns out, there is a common factor: explosive revenue growth thanks to new product launches. Backing out the three companies with negative growth, these companies have an average compound annual revenue growth rate of nearly 39% over the past five years. This is what happens when a small biotech with no marketed products hits it big with its first drug launch.

Consider Celgene, a biotech whose gains have come on the back of two approved cancer drugs, Thalomid and Revlimid. The company just reported a phenomenal year, with revenue growth of 56% pushing the top line to a whopping $1.4 billion. This year, Celgene expects 30% growth and $1.8 billion annual sales, putting it in an elite class of biotechs.

It's no wonder this stock has increased tenfold in five years. But there is increasing competitive threat on the horizon with Millennium Pharmaceuticals' (Nasdaq: MLNM  ) Velcade up for FDA review as a first line treatment in multiple myeloma.

Elan has also done very well (despite seeing negative revenue growth), recently gaining approval for Tysabri in the treatment of Crohn's disease. Tysabri is partnered with Biogen Idec (Nasdaq: BIIB  ) .

An even bigger piece of news came out last December when Elan and big pharma partner Wyeth (NYSE: WYE  ) announced the beginning of a phase 3 trial for bapineuzumab in the treatment of Alzheimer's disease. Current therapies for Alzheimer's disease are only modestly effective. If bapineuzumab turns out to be a major breakthrough, it could keep the returns coming for Elan shareholders.

The Foolish spoonful of sugar
The returns above show that as investors, to lock in the big gains, we need to be there before drug approvals happen. This means we need to find high-quality drugs that are in early clinical development, before their potential is recognized by the rest of the market.

As a biotech analyst on the Motley Fool Rule Breakers team, I focus on finding small-cap biotech companies on the verge of releasing new products. More importantly, I want to find them before anyone else does. To see the biotech companies I'm recommending today, click here to join Rule Breakers free for 30 days.

This article was first published on May 17, 2007, as "Start Making $67,000 Today." It has been updated.

Fool analyst Charly Travers really does own shares of only biotech companies -- although he doesn't have a position in any company mentioned here. Millennium Pharmaceuticals is a Rule Breakers recommendation. Biogen Idec is a Stock Advisor pick. The Motley Fool has a disclosure policy.  


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