Stock-picker Cathie Wood had a fantastic 2020. All five of her funds doubled in value last year. And what's even more impressive is how she's diversified among several sectors. She has an innovation fund, ARK Innovation ETF, that ran up 152% in 2020. She also has funds that specialize in robotics, fintech, and the next-generation internet.

But her strongest performer last year was actually her biotechnology fund, ARK Genomics Revolution. That fund almost tripled for investors, running up 180% for the year. Her top holdings in the health sciences include Teladoc Health and Pacific Biosciences of California.

One of Wood's winners is Schrodinger (SDGR 0.28%), a biotech company that uses high-speed computers to help companies find new drugs. Wood is not the only superstar investor backing Schrodinger -- Bill and Melinda Gates own 11% of the company. Schrodinger is still small, with a market cap of $5 billion. But the long-term upside is significant. Read more to see why you might want to own shares of this revolutionary biotech. 

Medical researchers using computers in the lab

Image source: Getty Images.

Speeding up drug discovery

Finding new drugs is incredibly difficult, time-consuming, and costly. Using human researchers, it takes a drug company four to six years to find, synthesize, and test 5,000 molecules in the hopes of finding a drug candidate. Two-thirds of these drugs fail to make it to human trials. This trial-and-error approach means that a drug company will spend on average $35 million finding a molecule good enough to test in people.

And, of course, that's just the beginning of the process. Drugs have to get through three levels of human testing (phase 1, phase 2, and phase 3) before all the resulting data is submitted to the U.S. Food and Drug Administration (FDA) in hopes of approval. Each level of human testing is more expensive than the last.  

Schrodinger's software dramatically speeds up drug discovery. A biotech company using Schrodinger's platform can test billions of molecules in days. Not only is this a faster and cheaper way to discover drugs than by traditional methods, the results are superior.

Using Schrodinger's software, biotechs can now find molecules with a much stronger affinity for the drug target. These drug molecules work by binding to a protein in the human body, and in one peer-reviewed study, Schrodinger's software was eight times more effective than traditional methods in finding molecules with high affinity for the drug target.

A tech partner for big pharma (and beyond)

Not surprisingly, drug companies are big fans of Schrodinger, a company that's been around for 30 years. Out of the top 20 pharmaceutical companies, would you care to guess the number that use Schrodinger's software? All 20 of them do. Last year, Schrodinger had $92 million in software revenue, up 39% from 2019. Roughly a third of its software revenue ($32 million) came from its top 20 clients.

In 2020, Schrodinger had 16 contracts worth $1 million or more, up from 10 in 2019. And there's still more room to grow. Schrodinger estimates its larger pharmaceutical clients have only purchased enough software capacity to optimally enable one or two drug discovery projects. As large pharmaceutical companies typically have scores of research projects under way, there is plenty of opportunity for Schrodinger to increase software sales to its existing customer base.

One exciting thing about Schrodinger is that its physics-based software has applications outside of drug discovery. Management believes its platform may revolutionize a wide variety of sectors in materials science, including nanotechnology, the manufacture of thin films and polymers, and energy storage and consumer goods.

And it's a drug company, too

Schrodinger is proactively using its software to find its own drug candidates. Last year, Bristol Myers Squibb (BMY 0.42%) paid the company $55 million to find drug molecules. The deal includes a whopping $2.7 billion in payments Schrodinger will receive if these new drugs pass future milestones. If the drugs are eventually approved by the FDA, Schrodinger will also receive royalty payments. Meanwhile, Bristol Myers Squibb takes on all the financial risks of drug development. 

Demand for Schrodinger's technology has increased dramatically. Six years ago, Sanofi (SNY -1.24%) signed a similar agreement, except the numbers were much smaller. There was no reported up-front payment, and if Schrodinger's molecules hit various milestones, the company would receive up to $120 million. So that's a dramatic increase in the perceived value of Schrodinger's offerings -- from $120 million to $2.7 billion in six years.

Schrodinger is also collaborating on a drug discovery platform with Japanese pharmaceutical giant Takeda (TAK 0.34%). In addition, Schrodinger has collaborative programs with 10 smaller biotech companies, not to mention all the drug discovery it's doing in-house.       

Schrodinger's drug program is in very early days. So far, none of the company's drugs have even started phase 1 trials. But given that its collaborating partners already have two drugs on the market and multiple drugs in clinical trials, there's reason to be bullish that Schrodinger's in-house pipeline will soon have drugs ready for human trials. (Management expects three of the Bristol Myers Squibb drugs to achieve that milestone next year.)

Why Cathie Wood owns shares

While Schrodinger is not Wood's biggest biotech investment by any means, you can see why she owns almost $200 million of the stock. The company is using advanced technology to disrupt the traditional path of drug discovery. Because of Schrodinger's platform, finding drugs will be faster and cheaper in the years ahead. Investors should profit nicely by following Wood into this stock.