10 Biotech Stocks With a Sky's-the-Limit Future
Even though neither Johnson & Johnson (JNJ - Get Report) nor Alza (AZA) is a pure biotechnology stock, I think the announcement that Johnson & Johnson will buy Alza for $10.5 billion in stock is great news for biotechnology investors.
The deal confirms, in my opinion, that despite the stomach-churning volatility in the sector over the past year, the fundamentals driving the long-term appreciation in the value of biotech stocks remain intact.
That's not small comfort, either. In the past year, biotechnology stocks have ridden a roller-coaster course that makes the path of the
Nasdaq Composite Index look almost sane. After peaking just shy of 800 on March 6, 2000, the
American Stock Exchange Biotech Index
I've been following the recent debates among analysts over whether the March 21 low marks some kind of a double-bottom in the sector. Frankly, I don't have any idea if that's the case, and I suspect that it's no more possible to call the exact bottom in a sector than it is to pinpoint the exact bottom in the market as a whole.But fortunately, the "buy and forget" strategy that I use for the portfolio of biotechnology stocks that I've been putting together for Jubak's Journal since 1998 doesn't rely on calling bottoms and tops. Following that strategy, it's enough for me to know that biotechnology stocks are relatively cheap right now -- and that the fundamentals driving the appreciation of these stocks over the long term are still intact.
Betting on the FutureWhich brings me back to the Johnson & Johnson/Alza deal. Why does this convince me that the sector is still a good long-term bet despite its recent volatility? Because the willingness of big drug companies such as Johnson & Johnson, Merck (MRK - Get Report), Pfizer (PFE - Get Report), Eli Lilly (LLY) and others to pay biotechnology companies to find new drugs, and then often to buy those companies when the research pans out, is the single most important factor in supporting the stock prices of biotechnology companies. Oh, it's great when a biotechnology company such as Cor Therapeutics (CORR - Get Report) actually gets a drug approved by the Food and Drug Administration, launches a successful attack on the market and racks up significant sales. Integrilin, Cor Therapeutics' drug for angina, has recorded more than $100 million in sales over the past 12 months and is now the top drug -- by one measure, anyway -- in a three-drug market. But most biotech companies have to be valued on their drugs-in-progress. Even a company such as Cor Therapeutics deserves a market capitalization of $1.3 billion only if its pipeline contains at least a few future winners. Biotechnology companies depend on the big drug companies to strike research and development partnerships that will help them finance the most promising of these drugs -- in exchange for a piece of the future action. Investors, in turn, depend on these deals for information on which drugs in development might be the most valuable when they finally reach the market. Investors also depend on the occasional acquisition of an entire drug development company to value a development-stage biotechnology company. You can see how this works pretty clearly in the purchase of Alza. Johnson & Johnson is paying $10.5 billion to buy Alza, a company that analysts project will have $1.2 billion in revenue in 2001. The deal fills a growth hole in the big drug company's current drug lineup. Pharmaceuticals accounted for about 40% of Johnson & Johnson's overall sales in 2000 and about 60% of the company's profits. But Johnson & Johnson has had several promising products fizzle in development recently, and blockbuster drugs such as Procrit/Eprex for anemia and Risperdal, an antipsychotic, are about to face tough new competition. In buying Alza, Johnson & Johnson gets ownership of promising drugs such as Concerta, a treatment for attention deficit disorder, and Ditropan XL, an incontinence drug, that Alza doesn't have the money or the sales force to fully market. Plus Alza's drug-delivery technologies will give Johnson & Johnson a way to improve the efficacy of its existing drugs and perhaps a way to extend their lives in the market. (Johnson & Johnson has gone this route before, having bought biotech leader Centocor in an earlier deal.) The trends that have driven stock prices higher in the biotechnology sector in the past -- and that will do so again in the future -- are on exhibit in this deal. Big drug companies are still hungry for new products to fill holes in their pipelines and will pay top dollar for promising compounds. And they will pay even more for drugs that are far along or at the end of their clinical trials. That's not a minor point. Biotechnology companies, after years of bringing almost no drugs to clinical trials, now have scores of candidates ready for the Food and Drug Administration.
A Sky's-the-Limit FutureMy four-rule biotechnology strategy is based on the real potential and the real risk of investing in this sector. I think biotechnology has a sky's-the-limit future. Some of the companies using these technologies will produce drugs that will rack up $1 billion in annual sales. Every investor, in my opinion, should have some money in the sector. But I also know that predicting precisely which companies will wind up owning $1 billion drugs, and which will end up blowing $1 billion in investors' capital on the drug-industry equivalent of dry holes, is extremely difficult. And I know that the long lead time from research program to drug test, and the incredible volatility of stocks in this sector, can wear out the nerves of even the steeliest investor. That's why I've built my biotechnology portfolio around these four principles:
Portfolio ReviewFrom the time I began constructing this portfolio in September 1998 until last August, I used these rules to pick 10 stocks to fill out a portfolio. Now that the list is complete, I'm going to concentrate on fine-tuning it every six months or so by replacing the stocks of companies that have lost their way -- or that simply look less promising -- with the occasional newcomer. In this column, for example, I'm going to make one new pick and drop one stock, Microcide Pharmaceuticals (MCDE), from the list. First up -- Cell Genesys (CEGE).
|Market cap: $501 million|
|Gain since 9/24/99 pick: 86%|
(CORR - Get Report)
|Market cap: $1.3 billion|
|Gain since 3/4/99 pick: 406%|
|Market cap: $122 million|
|Loss since 8/11/00 pick: 76%|
|Market cap: $2.3 billion|
|Gain since 9/25/98 pick: 171%|
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