Biotech investing is inherently speculative. Despite all we think we may know about a company's drugs, there's a lot of educated guesswork that goes in to deciding whether or not a company is a good investment. I view the process as weighing probabilities. What are the odds I am right and what is the upside if that judgment call plays out? And if I am wrong, what is the downside?

That is the simplest way to break down investing in the unknown. It's a lot like playing poker. You bet strong to maximize your gains when everything is in your favor, and you lay the cards down to minimize losses when things aren't looking good. I feel pretty strongly that biotech investors who grasp the probabilistic nature of dealing with unknowns are going to trounce the market, albeit with the inevitable ups and downs.

But that is only one way to tackle the sector. Believe it or not, good old-fashioned fundamentals can come into play. If you are a traditionalist, this may set your mind at ease, since you can value such things as earnings and earnings growth and avoid the finger-crossing game of hoping a drug works out.

So this article goes out to all those investors who like to hang their hats on companies that have solid earnings and good growth potential. I'd like to welcome you into the biotech fold and show you that it's not all glitzy tech void of substance.

Real products, real profits
Earlier this year I highlighted the value in Canadian drug company QLT (NASDAQ:QLTI), and I even recently reiterated that the company was still a value. Despite thinking QLT was a great investment this entire time, I have clearly been on the wrong side of the market, as QLT's stock has been in a deep funk.

There are two big reasons for the swoon. The first is that the market does not like the competitive threats to the company's flagship product, Visudyne, which is marketed by partner Novartis (NYSE:NVS) for the treatment of age-related macular degeneration. Last year, Visudyne sales reached $448 million, and the company expects sales of $500 million to $530 million this year.

Wall Street is not buying the growth story, and it is clearly betting that competition is going to eat into those sales. Eyetech Pharmaceuticals (NASDAQ:EYET) and Pfizer (NYSE:PFE) recently launched Macugen into this market, and other late-stage drugs, such as Lucentis from Genentech (NYSE:DNA), are looming. While these are certainly worthy competitors, I don't think it's yet clear that they will used in lieu of Visudyne, rather than along with it.

There also appears to be a fear that QLT's second-biggest product, the prostate cancer treatment Eligard, is going to disappoint. This drug had $84 million in sales last year but is in a tough competitive environment and is also facing pricing pressure from Medicare. The entry of a long-lasting six-month formulation that won't have to compete head-to-head with market leader Lupron could be a shot in the arm, but clearly the market is taking a "show me" stance.

Primarily from royalties on sales of Visudyne, last year QLT had revenues of $186 million and earnings per share (EPS) of $0.54 after merger-related expenses are backed out. With a current share price of $12.89, that gives a trailing price-to-earnings ratio (P/E) of 24. That may not sound cheap for those used to looking at the S&P 500, but in the context of the biotech sector it stands out as below the norm.

I think it's an even bigger anomaly when considering the company's stated guidance for this year of a non-GAAP EPS of $0.63 to $0.77 when restructuring charges are backed out. If they hit the midpoint, that gives a forward P/E of 18. That may be commonplace for big pharma, but is almost unheard of for a small drug company.

So what is going on? What we are seeing at work here is that when fast earnings growth is expected to come to an end, a stock will get hammered. The concerns about Visudyne and Eligard are legitimate, but to me it seems that the pessimistic view has already been priced into the stock. I am not at all convinced that the doom and gloom scenarios for the drugs will come to pass.

There is also the matter of the market's near-term blinders. A lot of the time the market only cares about the current year, or even the current quarter. Anything further out is deemed irrelevant. If we take the mind-set that a shareholder is a part owner of a business, which is what we advocate here at the Fool, then such short-term myopia is ludicrous. Value is created in the time frame of years, not months.

In that light, it is worth pointing out that while the market has been fixated with what could go wrong with QLT's marketed drugs, it has completely ignored everything else in the pipeline that could contribute to long-term growth. I would say right now that the pipeline is essentially coming for free. Of course, not all of the drugs will work or become commercially successful, but when no chance of success is priced in, then I'm certainly interested.

Of special note is the potential approval of Aczone for the treatment of acne. Within the next three months the FDA should decide whether or not to grant approval. I'm also particularly interested in the diabetic retinopathy drug Octreotide, since it carries low technical risk because it is a proprietary formulation of an already-approved product. While these drugs are not flashy and won't likely be huge sellers, they represent underappreciated assets that seem to be ignored right now. They should also provide a positive return on the money invested in their R&D, and those are the kind of programs I like.

Bottom line
On the fundamentals I see QLT as a good value -- not just on the financials and the valuation multiples, but also for a pipeline that is completely overlooked. But I also want to tie this in to my earlier comments on weighing probabilities. If I am right and QLT continues to perform better than the market expects, I see a lot of upside from the current stock price. And if I'm wrong and the company's growth does indeed slow, then the downside would appear limited as it's the anticipated outcome that is already built into the stock. This time, the smart move is to bet against the market.

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Motley Fool Rule Breakers biotech analyst Charly Travers owns shares of QLT. The Motley Fool has a disclosure policy.