More often than not, reaping a reward means taking some kind of risk, and that's undoubtedly the case when it comes to investing in the biotech sector.
To say biotech is complex is an outrageous understatement. Short of blind luck, whether one turns a personal profit from biotechnology bets relies heavily on research, scientific knowledge and a genuine interest in a particular company's fortunes.
For those reasons and others, many investors opt to pay someone else to invest in biotech for them. For the bulk of individuals, especially those who don't trade for a living, that probably isn't a bad idea.
Consider that according to the Biotechnology Industry Organization, a trade group, there were 1,473 biotechnology companies in the U.S. as of Dec. 31, 2003. Of the total, 314 were publicly traded. Numbers like that can be daunting, even for professional investors.
"It's difficult for a manager to find 40 good biotech companies without looking too much like a biotech index," says Kevin DeGeeter, senior equity analyst at H.C. Wainwright, a New York-based investment bank. "Just owning shares of the biggest biotechs is not enough to get a real taste of the biotech industry."
DeGeeter says that to be a winning investor in biotech, one has to start by looking for companies that aren't already facing outlandish expectations or currently residing at the top of the food chain.
is not owning biotech, it's owning annuities on certain drugs," DeGeeter says.
For those who do want to take a chance on individual companies, the wise move would be to choose a specific area of biotech on which to focus, preferably in a market that isn't too crowded. In other words, not cancer and not heart disease.
DeGeeter, for example, might look at companies studying autoimmune diseases like rheumatoid arthritis and infectious diseases like those caused by staphylococcus bacteria. These diseases can be easier for investors to grasp because they're more symptomatic, he says. "And understanding what a drug is intended to treat, the market and the competition is key," he adds.
Within a specific disease area, pick two or three companies, DeGeeter suggests. "No one with a straight face is going to tell you to own one stock" for one disease, he says. "No matter how smart you are, you can't avoid the losers."
Jim Gale, the managing director of a Sanders Morris Harris private equity fund focused on life sciences, says for individual investors, portfolio theory is essential, and he recommends a long-term investment strategy.
Too many times, he says, retail investors run into trouble after a company announces that it expects to report trial results, and people start placing bets on what the outcome will be. "That's not smart investing," he says. "You may as well go to Atlantic City."
Gale suggests investing in a sector play like the Amex Biotechnology Index, whose members and movements are tracked, for instance, by the
Biotechnology Basket Opportunity Exchangeable Securities
Other broad-based biotech securities include the
SPDR Biotech ETF
, both of which are designed to track a group of companies, rather than an individual firm.
However, for those who are set on picking individual stocks and are willing to take on the added risk, Gale says little companies working on treatments for obscure diseases could be promising. "Smaller companies are going to give you more bang for the buck -- if they're successful," he says.
As examples, he cites gene therapy companies
and stem-cell company
. All saw significant run-ups late last year.
Still, he knows that larger biopharmaceutical companies like
have a way of pulling in investor capital.
Regardless of whether one's focus is on long-term or short-term investing, on funds, on ETFs, or on individual stocks, money managers and analysts agree that sound investing in biotech requires homework.
"You have to know the sector and follow scientific research," says Stephan Patten, a health care fund manager at Sectoral Asset Management of Montreal. Patten's
Quaker Biotech Pharma-Healthcare fund doesn't hold companies unless he's convinced of their development prospects.
"In the Quaker fund, we have the flexibility to invest in companies even before phase I trials," Patten says. Phase I is the first stage of a drug's use in humans. At that point, companies, especially those with no commercial products, can't be valued on earnings, profit growth or sales.
Patten, therefore, looks at enterprise value or a price-to-cash ratio in order to determine the worth of a company that's in the early stages of a product's study.
While small companies conducting clinical trials on experimental products are sometimes viewed by investors as potential acquisition targets, money managers might disagree about whether to place wagers on names based on their perceived takeout value.
Patten chooses to key on the prospects of the stock, the company's particular drug and how it's faring in development. "If in the process it gets acquired, so much the better," he says. "But that's an area that's very speculative and very tough to predict."