Avoid the Shiny Happy Morons

Twelve years ago, renowned Russian political scientist Igor Panarin predicted that the United States will break up into six separate nation states later this year ... 'round about June, in fact. This will complicate my taxes, since I live in a part of the country that will be controlled by China starting later this summer, while my employer will become part of the European Union.

Predicting the future is a notoriously unreliable business, yet it's unavoidable. You can't plan for the future without making assumptions about what's to come. Most of us learn intuitively that predictions get hairier the further out they look and the further they depart from the status quo. The weatherman does a decent job of telling you if it will be sunny on your drive to work tomorrow. Just don't trust him to tell you if you'll be commuting to work in a flying car 20 years from now.

I'm risking apostasy here, because I'm part of the Rule Breakers team -- the Motley Fool service that deliberately seeks out the Companies That Will Change Everything, the businesses that disrupt their industries, the single investments that can transform a portfolio. Yet here's the rub: If the qualities that will lead a company to vast success are obvious or easily foreseeable, they're less likely to be highly profitable. On the other hand, if you see something in an investment that no one else sees, there's a good chance you're wrong.

How do you handle this conundrum? By remembering that what makes markets is divergent viewpoints, not crystal balls. In other words, you're not really betting against the unknown so much as you're betting against other people.

Shiny happy morons
That was never more obvious than it was 10 years ago this week, when investors reached an apogee of optimism about the future. Many stocks, particularly technology stocks, hit all-time highs that they've never since come close to revisiting. Most people were wrong -- badly wrong -- about the stocks they were invested in.

But here's the kicker: By and large, the broad predictions these investments were based on -- that the Internet would transform business, that our new understanding of the genome would reshape medicine, that technology would continue to drive new innovation at an accelerating pace -- all became true.

The gulf between accurate generalities and mistaken specifics is often chalked up to inflated valuations: People weren't necessarily wrong about the companies they bought, just the price. Examples are plentiful. Successful companies like Cisco Systems and Juniper Networks (Nasdaq: JNPR  ) have continued to see their businesses grow even though they have never regained more than a fraction of their dot-com bubble peaks.

But let's face it: Many investors also were wrong about the companies they chose -- they picked unproven players in exciting new niches and got stung. With patience, a good company bought at a bad price can often grow into its valuation. A bad company, on the other hand, is probably going to stay bad. And bad companies at ridiculous prices -- like we saw so often 10 years ago -- well, that's a recipe for disaster.

A sleep-easy portfolio ... in biotech?
Consider biotech, an industry many investors still shun as the province of gamblers and small-f fools. Broadly speaking, the industry has earned that image. The Nasdaq Biotech Index, which tracks 125 public biotechs and thus offers a pretty broad industry snapshot, is down about 40% over the past decade. Sure, that's somewhat better than the Nasdaq Composite has fared, but it's far worse than the already dismal 20% decline in the S&P 500. Biotech, in general, has been a bad place for investors.

Now here's a list of 10 biotech companies that I chose using the following criteria: They were all part of the small, quality-focused AMEX Biotech Index (BTK) back in 2000 and, with the exception of Genentech, still are today. They are and were among the most recognizable names in the industry, and each one already had a product on the market 10 years ago.

Company

Value March 10, 2000*

Value Today

Change

Celgene (Nasdaq: CELG  )

$14.04

$61.59

339.0%

Gilead Sciences (Nasdaq: GILD  )

$4.48

$47.01

949.0%

Amgen (Nasdaq: AMGN  )

$59.56

$57.61

(3.3%)

Vertex Pharmaceuticals (Nasdaq: VRTX  )

$33.03

$41.40

25.3%

Cephalon (Nasdaq: CEPH  )

$63.25

$70.85

12.0%

Biogen Idec (Nasdaq: BIIB  ) **

$43.10

$57.67

33.8%

Genzyme

$28.81

$57.22

98.6%

Genentech***

$46.38

$95.00

104.8%

Affymetrix

$128.81

$7.85

(93.9%)

*Split-adjusted as necessary.
**Stock price in 2000 represents Biogen, the surviving company of the 2003 merger between Biogen and Idec.
***The remainder of Genentech was acquired by Roche in March 2009 for $95 a share.

Not every one is a winner, but this basket would have you crushing the market, even if you bought at the market peak a decade ago. And none of these investments required oracular visions of the future. These were successful companies with proven track records. They were, to a large degree, the obvious choices within sector.

Oracular spectacular
We all want to hit home runs, but that doesn't mean taking wild swings. Making sensible, well-researched prognostications about the future can guide you toward industries and businesses likely to grow in importance.

At Motley Fool Rule Breakers, we don't have to forecast the downfall of nations before our next dentist appointment to recognize that areas like nanotechnology, cloud computing, robotics, and molecular diagnostics are likely to have a huge influence over the coming decade. At the same time, we know the future will throw us curveballs that none of us can anticipate. And knowing that will happen, our best defense is to concentrate on quality and track record, not flash and high concept. These are the businesses that will thrive even if things don't quite play out the way we -- or they -- expect. 

If you're interested in learning more about our way of investing, and seeing all of our stock recommendations, a 30-day trial run is absolutely free. Here's more information.

Rule Breaker analyst Karl Thiel owns no companies mentioned in this article. Vertex Pharmaceuticals is a Motley Fool Rule Breakers choice. The Fool has a disclosure policy.


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