Can I plead ignorance? One salty experience more than a decade ago soured me on biotechnology stocks. I swore them off, but now I'm starting to regret blacklisting the promising space. I work with Charly Travers on the Motley Fool Rule Breakers newsletter service, and I've seen way too many of his biotech picks take off.
I'm happy for Charly. I'm pumped to see our subscribers doing so well. Deep down inside, though, I'm probably a bit jealous. I want in on the fun. I think I need to get up to speed on this life-altering industry. That's why I did what many subscribers do: I turned to Charly for a little guidance in the bold and beautiful ways of biotech investing. The conversation I had with him follows.
Rick: Charly, a dozen years ago, I bought shares of Amgen (NASDAQ:AMGN). I sold a few months later at a loss. Yes, I'm the guy who actually lost money on Amgen! Since then, I have pretty much sworn off biotechnology stocks. I'm in awe of the field, but I'm just afraid to buy into a sector where I'm just a nutty ol' ignoramus. Is that rational behavior? Is the learning curve to being a successful biotech investor as huge as it seems?
Charly: There is something to be said for investing in what you know. But that doesn't mean you can't learn something new if you're motivated and willing to take the chance. While there is a long and steep learning curve, investing in biotech isn't all that different than investing in any other sector. Essentially, drugs are just products that need to be created and then sold for a profit. When you boil it down to that basic concept, investing in a biotech company isn't much different from investing in a computer-chip maker or a clothing retailer.
Rick: How did you get started in biotech investing?
Charly: My initial career plan coming out of college was to be a scientist. I went straight out of college and right into grad school, where I was doing cancer-related research in the pharmacology and physiology department at St. Louis University. While I was in the midst of my studies, biotech was all over the news as Celera Genomics, now Applera (NYSE:CRA), was racing the National Institutes of Health to complete the sequencing of the human genome. That opened up a whole new world for me that I didn't even know existed. I quickly became fascinated with the business of science and fell right into analyzing companies. It wasn't long before I was hooked on it and ditched the lab coat for the Fool's jester cap.
Rick: You have made some pretty amazing picks for the newsletter that we both work on, Motley Fool Rule Breakers. Vertex Pharmaceuticals (NASDAQ:VRTX) has soared 280% higher since you singled it out last year. You recommended Exelixis (NASDAQ:EXEL) just five months ago, and it's already surged 58% higher. What attracted you to those two companies, and can you explain what they do in terms that even I would understand?
Charly: Finding the opportunity is pretty easy, and anyone can do this. We all know people who are or have been sick with some disease. There's a huge laundry list we're all familiar with. Arthritis, Alzheimer's disease, cancer, diabetes, and so on. My approach is generally to pick one of these diseases where current treatments are lousy and then to scour the biotech universe to try to find a company doing something new and interesting in drug development. That's what led me to Vertex. I happened to be looking for drugs for hepatitis C because it's a huge medical problem where the existing drugs work for only half of the people infected by the virus. There was a big opportunity for a company to enter that market. I came across Vertex and saw that it was developing a new drug, VX-950, that went after the virus in a completely new way. Well, that got me excited, and I took the plunge. Since the pick was made, the company has shown some preliminary data that is very encouraging, and the shares have soared.
Rick: OK, let's go in a different direction. Tell me about a company that you almost considered recommending to our newsletter subscribers until it didn't make the cut with you. What turned you off there?
Charly: This is an easy one. Elan (NYSE:ELN) has been one of the biggest biotech stories of the past 18 months, with its multiple sclerosis drug Tysabri getting approved, then getting yanked off the market, and then recently looking like it will go back on the market. The stock dropped almost 90% last year, and I very seriously thought about picking it. What held me back was that I thought there was just too much risk at the time to make it an official newsletter pick. As the picture around Tysabri brightened, the stock took off. What that meant for me was that as the drug's risk declined, the company's valuation became less attractive. So for different reasons over the course of the past year, the stars never lined up for the company to get the nod as a recommendation.
Rick: Help me out on clinical trials here. There are three clinical-trial phases, but it seems to take forever for a successful drug to make it all the way through. How long does it take, and is this just like that poor bill that wants to become law in Schoolhouse Rock?
Charly: Kinda like that, but without the "I'm just a drug" jingle. Let me switch over to a baseball analogy. Baseball teams have deep farm systems where they develop their young players. At the bottom level, you have single-A leagues. A step up from there is AA. Then finally right under the majors is AAA. Players start at the bottom and work all the way up to the major league if they're good enough. The vast majority of players work their way up a little bit but never make it to prime time. Drug development is a lot like that, where phase 1 is entry level -- a new drug is tested in people for the first time. If it looks good there, it moves on to phase 2, and if it's good there, then it's on to phase 3, which is the final stage of development. Phase 3 is like AAA baseball. Almost there, but not quite. If you get past that step, though, you've made it. To take a drug all the way from phase 1 through phase 3 and onto the market can take anywhere from five to 10-plus years.
Rick: Man, that's a pretty long time. So when is the ideal buying point once you're convinced that you've found a winner? If you buy too early, you're going to get a great price, but you may be sitting on years of waiting for a drug to get on the market. If you buy too late, you're going to pay more, but at least there is a little more visibility there. What's the compromise that works best for you?
Charly: I like to buy early in development, around phase 1 or 2, typically. While it can take more than five years to take a product at that stage all the way to market, that does not mean that the early investors have to wait that long just to see a return on their investment. For example, both Vertex and Exelixis have been great performers for us as their programs moved from phase 1 into phase 2.
Rick: Most of us associate biotechnology with finding cures and treatments to human diseases, but biotechnology is also big in areas like agriculture, where farmers are trying to grow better tomatoes. As a growth stock investor, where should I be concentrating my due diligence when it comes to biotechnology?
Charly: There are interesting agricultural or industrial applications. But that's just not what I'm interested in, personally. I think drugs are the way to go. But stick with technologies that are already proven, like monoclonal antibodies or other protein drugs. Stem cells or other exotic technologies may make for fun water-cooler chatter, but they've got a long way to go before a commercially viable product is created. We're investors and not research scientists, after all. We need tangible products and not research products.
Rick: I made a huge mistake in selling Amgen back then. Is it too late to buy Amgen now? Should I be looking for the next Amgens instead of the current one?
Charly: I don't think it's too late to buy Amgen at all. For the first time in years, I actually like Amgen's stock. For investors who want to dip their toes in biotech but don't want the risk or volatility of a small-cap company with no products, Amgen is a great option. It's essentially a large pharmaceutical company at this point, except that it has better growth prospects and far less patent exposure. While my personal investment style is to go for small-cap biotechs that could explode into big ones, like Amgen, there's absolutely nothing wrong with going for the real thing right now. It's just a matter of taste.
Rick: Thanks, Charly.
I'm still a little jealous, but I don't hate biotech anymore. Deep down inside, I probably never did. Ignorance made for a flimsy crutch. I was asleep, you know. For way too long. Genentech (NYSE:DNA) has been a 12-bagger over the past 10 years. ImClone Systems (NASDAQ:IMCL) has been a 10-bagger over the same period. Amgen? I can't believe I slept through a five-bagger.
I'm awake now. I've got Charly and a smart community of analysts and fellow subscribers to make sure that I don't snooze off again. You can join me there as we both learn together. You can even go with a free 30-day trial subscription if you're still not ready.
It's a new day. You can't hate what you don't know.
Longtime Fool contributor Rick Munarriz finds that eating, sleeping, and breathing growth stocks will work wonders for your financial health. He does not own shares in any of the companies mentioned in this story. Charly Travers owns shares in Vertex and Exelixis. The Fool has a disclosure policy. They are both part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.
