When the market's investing groupthink leaves a slew of companies for dead, you can bet that some good ones have been thrown on the dunghill. Call it contrarian or value investing, but opportunities often lie where others won't. One of those places today is biotech.

Biotech? That's shorthand for companies using advanced life science to improve health care, especially the extraordinarily costly and time-consuming drug development process. Capital markets loved them in the 1999-2000 boom, embracing their initial public offerings (IPOs) and follow-on share sales. This gave many companies, especially those hoping to develop drugs and snare FDA approval, the cash to survive the decade or more until there was any chance of putting drugs on the market.

The biotech bull and bear
The words genomics and proteomics crackled in the investing ether, and then-bioinformatics company Celera Genomics (NYSE:CRA) proved the story stock of the era. Many investors, including me, bought the story and the stock with money available for high-risk investing. Boosted by investor expectations that the company would scoop the government in sequencing the human genome, Celera shares ran up seven times in two months (I get dizzy just writing that). Near the top, the company sold almost $1 billion of new stock. Today, its business plan is different -- it's hoping to make drugs and diagnostics instead of sequencing your genome. Celera's stock closed yesterday at $8.89, one-thirtieth of its all-time, split-adjusted intraday high of $276.

What's astounding is that Celera's story is not unique. Stocks of most companies using genomics-era biotechnology to advance drug development have been destroyed. If their stock prices were labs, someone let the rats out of their cages to run the place. During the three-year bear market, perhaps only telecom has had a bloodier, sadder fall.

Thereby hangs a tale
Celera is an anecdote, but the AMEX Biotech Index helps tell the story in broader, stark terms. The index is a decent proxy for the biotechnology and drugs arena, composed as follows:

Company Weighting in Index
Affymetrix 7.00%Amgen 6.86%Gilead Sciences 6.86%Human Genome Sciences 6.67%Medimmune 6.57%Invitrogen 6.47%Millennium Pharm. 6.41%Genzyme General 6.15%Chiron 6.02%Idec Pharm. 5.89%Celera Genomics 5.77%Genentech 5.44%Biogen 5.30%Cephalon 5.09%Protein Design Labs 4.94%Vertex Pharm. 4.44%Enzon Pharm. 4.12%

The index began on Oct. 18, 1991 at 200, and is rebalanced quarterly. Some of these companies, such as Celera, weren't public then, so a company will occasionally leave the index and another will join. Today's mix of companies is filled with risk -- whether they're successful companies at valuations leaving no room for error or those years from a penny of profit or free cash flow.

Some, such as Amgen (NASDAQ:AMGN) and Genentech (NYSE:DNA), first made their mark in recombinant DNA drugs. Genentech and others, such as Idec Pharmaceuticals (NASDAQ:IDPH), Protein Design Labs (NASDAQ:PDLI), and Millennium Pharmaceuticals (NASDAQ:MLNM), have monoclonal antibody drugs on the market or in development. Affymetrix (NASDAQ:AFFX) and Invitrogen (NASDAQ:IVGN) supply research tools. The rest are drug makers and hopefuls, toiling across the research and development spectrum.

Biotech vs. S&P 500
When we compare the index to the benchmark S&P 500 (dividends added) since the index's 1991 inception, this is what shows up:


AMEX Bio. Total Return CAGR Index AMEX S&P 500 AMEX S&P 50003/21/2003 351 75% 170% 5% 9% 12/31/2002 338 69% 181% 5% 10%12/31/2001 581 190% 261% 11% 13%12/31/2000 634 217% 310% 13% 17%12/31/1999 391 96% 351% 9% 20%12/31/1998 185 -7% 272% -1% 20%12/31/1997 162 -19% 190% -3% 19%
10/18/1991* 200
*Index inception

For the 11.5-year period, the S&P 500 has walloped the AMEX Biotech Index, though the latter did have a phenomenal 1999 and 2000. The difference in compound annual growth rates (CAGR) since 1991 is pretty astounding. Investors know well that an extra point or two of CAGR adds up nicely the more years you have it. The S&P 500 return since 1991 falls a little under the long-term average of 11%, while the biotech figures are lousy.

Numbers can mean anything, and you've already noticed that if you bought either index at the end of 1998, you would have done much better. But it's obvious in this 11.5-year sample that the broader market average was far less volatile than the industry or sector, as defined by the AMEX Biotech Index.

Companies, not industries
This is just one reason why I think it's misguided to invest in any sector or industry index fund. You want the best company or companies in an industry, especially a newer and uncertain one, not some watered-down "diworsification" of all of them. Don't buy sector mutual funds, such as those in biotech. They are Wall Street marketing vehicles designed to separate you from your money. Please either take the time and energy to find the best companies in biotech -- or anywhere -- or simply take comfort in matching the market's return through a low expense broad market stock index fund.

Why try to find the best investments in biotech? Consider that much has changed since the end of the 1999-2000 biotechnology capital funding boom. Venture capital is funding biotech and health-care companies at 1999 levels, but we aren't seeing the IPOs. IPOs are financing events for the companies, and almost never opportunities for investors. Companies go public at two points: Either the time of maximum market enthusiasm for a company or industry, or when the IPO market is weak, but the company's finances leave it no choice. Either time means danger for individual investors. Today, the lack of IPOs may be bad news for companies, but it's a contrarian positive for investors looking for values.

Companies using complicated biotechnology present special challenges to investors. They rarely produce products with household names. Laboratory research tools and monoclonal antibody drugs aren't often directly part of our everyday lives. But with some study and passion, it's possible to understand a business model well enough to know the risks and possible return, whether and when to buy, and when to sell.

Biotech, broadly
One lesson from the last biotech bull market is that we need to think more broadly about the sector than three years ago. Advances in understanding human health have spread, benefiting not just a few companies with "genomics" in their names or business descriptions. If we look beyond the hot stocks of the day into a broader health-care world, from over-the-counter products in your drugstore to diagnostics, medical devices, and, of course, drugs, there are values.

Consider a sleepy, 100-year-old research tool company with canny management. Starting in the last decade, it began quietly to buy companies with complementary genomics-era products on the cheap. Unlike many other acquisitive companies, it didn't overpay in the bull market, and in today's biotech bear market, it can find bargain-basement prices.

Management is investing capital in a far different way than a hot biotech drug maker. Sure, investors can roll the dice on that drug maker, wait five or 10 years or more, tie up money, and eat the opportunity costs. Many of us have. Or we can take our nice 10%- to 15%-a-year returns along the way, sometimes with a dividend, and do at least as well or better with less risk. Or we can do both. And in the middle are opportunities among biotech drug companies that aren't such a gamble but have been ignored.

In my search for promising companies selling at compelling valuations, I'm especially eager to share results from the biotech and broader health-care universe. In fact, I'll start next week with several. Along the way, I hope to see you devouring posts on our Biotechnology discussion board (painless free trial). Pay close attention to the columns Jeff Fischer started last week on generic drug makers, those savvy companies that take drugs at the end of their patent protection and make money turning out cheaper versions -- good for patients and possibly very good for investors. (You can always find Jeff or any Motley Fool writer's columns through the handy drop-down menu "Browse Stories by Author" on the Fool.com home page.)

Stay Foolish, and thanks to all for the kind birthday wishes last week!

Tom Jacobs (TMF Tom9) takes no biotech drugs, but when he's revved up, others suggest it. He often writes about biotech and health care for Fool.com, and pens the monthly investing column for the journal Nature Biotechnology. Tom owns shares of Millennium Pharmaceuticals and other companies you can find on hisprofile. Motley Fool investment writers areinvestors who write for investors.