If you thought Net stocks were tricky, try genomics.
The only sure thing about the emerging genomics industry is that billions of dollars in research money will be thrown at it. Some will pay off. A lot won't. And it may take years or decades for some research to bear fruit.
That's why analysts and investors now seem most apt to recommend pick-and-shovel companies that sell the tools to the hoards of drug companies joining the genomic gold rush. Thar's gold in them thar hills! You may not find any, but you certainly won't get anywhere without the tools. That thinking has had these stocks rallying in recent weeks, though Thursday morning saw a pullback that knocked the big biotech indices down by about 4%.
Fire to Play With
A decent track record won't hurt, either. "I go for revenue-driven companies, not companies that are in early stages," says Paul Knight, analyst with
, who recommends
( BIOI) and
Varian Medical Systems
, which all make products for the biotech industry. "They have established products and distribution networks," he explains. Weisel, which rates all three stocks strong buys, advised PerkinElmer in a recent transaction but doesn't do work for the others.
But, says Knight, "if you want to play with fire, there's lots of fire to play with."
And lots of momentum, too. The
Nasdaq Biotech Index
tripled over a year to early March, then lost 50% of its value over two months. Now the measure has nearly doubled off its lows, leaving it around 1300 Thursday, just 20% below its all-time high.
The companies that have benefited from the pick-and-shovel logic include
Human Genome Sciences
( HGSI) and
, all of whose shares have posted hefty gains over past year on hopes for their gene-research prowess. All sell research to big pharma companies, although Human Genome is also developing gene-based drugs.
A Place for Tradition
While Celera has been in the news most lately for compiling the first draft of the human genetic blueprint, all of these companies have been compiling data for years, mainly for big pharmaceutical and biotech companies. All are looking to find ways to manipulate the 100,000 or so genes in the human genetic makeup to find profitable new drugs.
And with cash coming from such alliances, tool-kit companies can be valued on traditional investment measures, such as net present value and earnings multiples, even though some, like Incyte and Human Genome, are still posting losses.
"The first person to get all the information is in a great position," says Matthew Murray, a fund manager with
new biotechnology fund. The fund is one of several that have formed in recent months to invest in genomics.
Will the genomic leaders of today be the defunct Commodore and Atari computer makers of tomorrow? Not in all cases, some investors say. That's because the barriers to entry in genomics field are higher than for computers. Furthermore, patents on genetic findings could ensure a steady stream of royalties in coming years from drugs on the market. "The founder effect is much more pronounced for these companies" than computer makers, says Murray.
How many new drugs will be created from genetic findings is an open question. Already there have been some 90 drugs from the biotechnology industry approved, mainly new drugs to replace or interact with proteins in the body, as well as vaccines and antibodies that target certain illnesses. But new gene maps are opening up hundreds of new targets for research.
But with unproved technologies and no established record of generating money, the old rules for investing apply, such as the portfolio approach. It's a rule of thumb among biotech investors that for every 10 stocks, one or two may succeed, two or three will be marginally successful and the rest will fail.
"We're going to be working on the genome for the next 100 years," says Steve Newby, fund manager with
GenomicsFund.com, a Maryland fund with $14 million invested in 21 genomics stocks. "There's going to be some wipeouts and some grand slam home runs."
The GenomicsFund, which was started in March, breaks out stock purchases into four main areas: pharmacogenomics, bioinformatics, analysis technologies and delivery technologies. The biggest sector in the fund -- and probably the highest risk -- is pharmacogenomics, which is finding new drug based on genetics. Top names in this sector include Human Genome Sciences (which not only has a gene database but is developing drugs based on it), Millennium,
Protein Design Labs
Newby says, "We stick with the leaders" in the sector, and the strategy seems to be paying off for now. With surging investor interest in genomic plays, the firm topped both
mutual fund performance rankings in the second quarter, GenomicsFund says.
Not everyone sticks with the leaders, of course. Some analysts see the future leaders in newer companies like
( ORCH) and
, the leaders of some 20 companies researching variations in genes called SNPs, or "snips."
"Billions of dollars will be tossed toward this area in the next few years, and the pie is big enough to support many players," says Tim Bepler, fund manager with
Orbitex Health & Biotechnology fund, a $300 million biotech fund with about 35% of its assets in genomic stocks. "We think a basket approach makes the most sense."
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