A Foolish Checklist for Biotech Investing

By Zeke Ashton (TMF Centaur)
June 13, 2000

Article Synopsis: Many investors see the potential that biotechnology offers but are mystified about where to begin. Investors new to biotech investing can use our Foolish checklist to assign a given company to one of three tiers and figure out whether it's got the stuff to succeed.

Biotechnology investing has been hot over the last year, the most recent Nasdaq plunge notwithstanding. The intense media scrutiny of the genomics revolution and the strong momentum in the sector means that many individual investors have hitched a ride on the biotech bandwagon. While biotechnology's amazing potential to revolutionize healthcare justifies a lot of the enthusiasm for the sector, investors need to be aware of its risks as well as its possible rewards.

The downside for companies that don't get FDA approval or aren't able to achieve their desired statistical endpoints in clinical trials can be severe. The stocks of such companies typically get whacked by investors when the bad news is released. Alkermes (Nasdaq: ALKS), which suffered a setback with the recent decision by partner Johnson & Johnson (NYSE: JNJ) to discontinue the development of a sustained-release version of J&J's Procrit, is the most recent example of this pi�ata effect. Biotech also involves some complicated technology, and much of it extends well beyond the knowledge of the average Fool. Even professional biotech investors have a hard time grasping the science at the core of many biotech products.

So how can your everyday Joe Fool hope to make any headway in the exciting but mystifying world of biotechnology? Let's see if we can reduce biotech investing to a reasonably simple formula.

Divide and Conquer
First of all, there's a wide variety of biotechnology companies out there. Some of them are already making rules in the industry and are raking in huge profits from products already on the market. Others have promising research pipelines and are close to breaking through with a new blockbuster drug that will propel them to profitability. Still others have promising technology but are still in the early stages of development. To simplify matters, I suggest that investors divide biotech companies into three groups: a top tier, which represents the established, large-cap biotech companies; a second tier, which includes companies that are close to being profitable; and a third tier, which includes everybody else.

The top tier consists of companies that already have one or more successful products on the market and enjoy minimum annual revenues of $500 million. Here are some of the companies in this tier: Amgen (Nasdaq: AMGN), Biogen (Nasdaq: BGEN), Chiron (Nasdaq: CHIR), Genentech (NYSE: DNA), Genzyme (Nasdaq: GENZ), Immunex (Nasdaq: IMNX), Medimmune (Nasdaq: MEDI), Biochem Pharma (Nasdaq: BCHE), and PE Biosystems (NYSE: PEB).

My advice to investors who want some biotech exposure but don't want to go back to school to get a biology degree? Start with this top tier. The companies on this list are all either profitable or will likely be profitable within the next year or two. In addition, the revenues that these companies are pulling in allow them to invest more money in research & development programs. While still risky, these companies will likely hold up better than others in the event of a disappointment in their research pipeline. They will probably also be more resilient in a nasty market sell off than second- and third-tier companies would. Finally, these companies lend themselves to traditional financial analysis much more readily than the other biotechs.

Now let's move on to the second group. There are many fine companies in this group that have either drugs on the market with growing sales or drugs that are potential big sellers in late-stage clinical trials. Also included here are the early movers in the much-publicized race to provide genetic information and gene-based drug discovery services. Let's call this group tier two. Some of the companies in this tier will go on to become huge winners, while others will never quite break through. All of them involve significant risk.

Some of the companies in tier two are: Gilead Sciences (Nasdaq: GILD), IDEC Pharmaceuticals (Nasdaq: IDPH), ICOS (Nasdaq: ICOS), IDEXX Labs (Nasdaq: IDXX), Celera Genomics (NYSE: CRA), Millennium Pharmaceuticals (Nasdaq: MLNM), Incyte Pharmaceuticals (Nasdaq: INCY), Human Genome Sciences (Nasdaq: HGSI), and Affymetrix (Nasdaq: AFFX).

Beyond the second tier, there are all those companies still looking to get their first drug to market or who are struggling to gain acceptance for their technology platforms. We'll call these the third tier companies. The companies in this group pose even higher risk than the companies in the second tier. Of course, the opportunity for huge percentage returns is also there, since many of these companies haven't been discovered by individual investors and are still off the radar screen of most institutions. Professional biotech investors and those with specialized knowledge have an edge with such companies, but an industrious Fool can still find a gold nugget in these waters.

If you find yourself captivated by a biotech company but don't know how to proceed, use the checklist below to help you in your analysis. It will help you in assigning your prospective investment to one of our three categories.

The Fool's Biotech Checklist
Biotech companies worthy of investment should have the following:

  1. Successful products on the market
  2. A deep product pipeline with late-stage candidates
  3. Drugs and candidates that target large or underserved markets
  4. Partnerships and marketing agreements with blue-chip drug manufacturers
  5. Research & development spending
  6. Enough cash to fund operations for two years
  7. Experienced management
  8. Favorable Foolish financial analysis
In my next Research article, which will appear on Thursday, I'll take you through a real-world example to demonstrate the use of this checklist. See you then!

Next: Using the Foolish Biotech Checklist »

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  • Motley Fool Research Report on Amgen
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  • How Large Can Celera Be?