One-Drug Wonders Deserve a Spot in Your Portfolio

Maybe it's the scientist in me, but I'm a pipeline kind of guy. Having multiple shots on goal from a single investment has seemed practical, perhaps even necessary.

But I'm warming to the idea of one-drug wonders, especially companies that have a clinical program in mid- or late-stage development and are on the verge of their first big hit. What the companies lack in safety, they make up in some special qualities.

Survival of the smallest
Cash burn rates have always been important to development-stage drugmakers, but the bear market, which has eliminated secondary offerings as an easy way to get more cash, has made it essential for investors to focus on how much cash a company is spending. Gone are the days when "if you build it they will come" was a legitimate investment thesis.

Simply put, the fewer drug programs a company has, the less cash the company will burn. Quite a few companies -- Anadys Pharmaceuticals, Dyax, and Replidyne, just to name a few -- have reassessed their pipeline and cut programs recently in order to try and extend their runway.

Bringing its A-game and leaving the second-best ideas on the back burner until the company has revenue coming in is a prudent use of cash in the current economic environment.

Looking good
Maybe the best benefit to investing in focused drug companies is the increased likelihood that the company will be acquired at a premium. Focused drug companies are attractive because the suitor can get exactly what it wants without a lot of extra baggage. And with fewer moving parts, it's easier for pharmaceutical companies to value their targets.

*Based on price before first bid was announced.

The more focused drug developers also tend to have fewer messy partnerships. Companies with multiple partners, like Exelixis (NASDAQ:EXEL) and Biogen Idec, are less likely to be acquired than more focused companies because the buyer doesn't have to deal with contracts with multiple partners, which might include change-of-control clauses.

While there's a higher potential for a buyout with focused companies, I wouldn't recommend buying solely because of it. There are no guarantees that a company will be taken out, and even if the company is purchased, there's no assurance that it will be bought above the price you paid. Omrix was a perfect fit for Johnson & Johnson -- the companies were partners and every analyst figured the two would eventually be wed -- but the 18% premium that Johnson & Johnson paid was still below where Omrix traded a year before.

Consider the potential for an acquisition as a fringe benefit, but make your decision based on fundamentals.

Buy two (or more), they're cheap
Companies aspiring to be the next Onyx Pharmaceuticals or Amylin Pharmaceuticals (NASDAQ:AMLN), with one major approved drug, are a bit more risky than companies with well-stocked pipelines. If the lead drug fails, they don't have anything to fall back on.

The way to deal with that risk is simply to diversify and build your own biotech ETF. You can establish your own personal pipeline of drugs by buying multiple focused drugmakers. Not every drug will make it through clinical trials and past the Food and Drug Administration, but all you need is one home run to make up for multiple failures.

Worth a closer look
Given that, here are a couple that I like today:

Dendreon (NASDAQ:DNDN) is perhaps the most famous of the potential one-drug wonders. The company's prostate cancer treatment, Provenge, has passed its phase 3 trials and an approval next year looks likely. The bull-bear debate rages on, but I think it still has potential to be a steady growth stock for the next few years until Provenge reaches its peak sales.

Technically, AMAG Pharmaceuticals (NASDAQ:AMAG) has a drug on the market already, but its GastroMARK is actually an imaging agent for MRI machines and brought in less than $1 million in revenue last quarter, so the company's future lies in Feraheme, its intravenous iron therapy for treating anemia. Investors shouldn't have to wait very long to see if the company has worked out its manufacturing issues that kept Feraheme off the market last year; the company said yesterday that it expects to hear from the Food and Drug Administration about an approval "within the next few days."

As always, be a Foolish investor and look more deeply into these companies before investing. One-drug wonders can really boost a portfolio, but they can also crash and burn.