Thank you,

Merck

(MRK) - Get Report

and

Pfizer

(PFE) - Get Report

and

Glaxo Wellcome

(GLX)

. My portfolio of eight biotech stocks wouldn't look nearly as fat without you. And that's not all you've done for me lately. You've ratified my decision to stick with biotech in the future as well.

What do the big drug companies have to do with the huge appreciation in biotechnology stocks? Plenty. The sky-high prices that companies are willing to pay in mergers to acquire a $4-billion-dollar seller like Lipitor -- the real prize that Pfizer gets for the $90 billion it's paying for

Warner-Lambert

(WLA)

-- has upped the value of any biotech company capable of producing a billion-dollar drug. And it certainly doesn't hurt the prices of stocks in this sector when even a research and development powerhouse like Merck admits that it's scratching for new products.

Investors Catch On to Biotechs

After ignoring this story for years, investors finally became believers in a rush. Biotech stocks, according to the

Biotechnology Index

, were up 98% in the last three months. That's quite a contrast to the 8% the index gained in all of 1998 and the 13% gain in 1997.

I don't think it's time to jump out of this sector yet -- the story powering biotechnology stocks is good for the next five years and beyond. Drugs will continue to come off patents at the major drug makers, and baby boomers will continue to age. Many biotechnology stocks, even among the recent winners, still sport market capitalizations well under $2 billion. Some of the biggest recent winners are still well under $1 billion in valuation.

Cell Genesys

(CEGE)

, for example, which is up 160% in the last three months, still has a total market capitalization of only $762 million. That's a far cry from the $20 billion market valuations awarded to money-losing Internet stocks like

Ariba

(ARBA)

and

Akamai Technologies

(AKAM) - Get Report

.

And I don't think it's too late to jump in, either. I can see every stock in my eight-stock biotechnology portfolio doubling again in a year. And in this column I'm adding another pick --

Ribozyme Pharmaceuticals

(RZYM)

-- that shares the low-risk, high-potential reward characteristics of my existing recommendations.

Rules for Biotechnology Investors

This column has three parts. First, a quick run through the four rules that I've used to pick biotechnology stocks since I started this portfolio in September 1998. Second, my standard six-month review of how the eight existing picks have done since September 1999, and what news I expect in the next six months. And, third, a new pick to bring the total portfolio up to nine stocks.

My four-rule biotech 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. I think every investor 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 spending $1 billion of 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 the stocks in this sector can wear out the nerves of even the steeliest investor.

That's why my biotech portfolio is built around these principles:

  • Buy enabling technologies. Look for companies that have mastered a research approach that is likely to lead to scores of potential drugs.
  • Buy products in the pipeline. Look for companies with a solid calendar of potentially positive news on drug tests and approvals.
  • Buy cash. Look for companies that have cash in hand or a proven record of raising cash to reduce the danger that they might run out of money at just the wrong moment.
  • Buy cheap stocks. Build a portfolio of inexpensive but promising companies, rather than trying to pick the next Amgen (AMGN) - Get Report or chasing the current market favorite.

Portfolio Review

Since I began constructing this portfolio in September 1998, I've used these rules to pick eight stocks. I still recommend each one of them as a buy at current prices. Here's a quick rundown on each one.

Cell Genesys

2/15/00 price: $23.13

9/21/99 price $7.69

Market cap: $762 million

Gain since 9/24/99 pick: 201%

The best thing to happen to Cell Genesys in the last six months is a deal that didn't happen. In October,

Genzyme

(GENZ)

offered to buy Cell Genesys for what amounted to a very cheap $350 million. Thanks to the rally in biotech stocks, however, Cell Genesys called off the deal in December -- a rising stock market had increased the value of the company's stake in

Abgenix

(ABGX)

by $240 million since the Genzyme offer. (Cell Genesys has subsequently sold 25% of its stake in Abgenix for $168 million.)

Cell Genesys, which focuses on developing gene therapies, is currently in Phase II clinical studies for its cancer vaccine for prostate cancer and in Phase I/II clinical trials for its vaccine for lung cancer. Additional potential products at the preclinical stage include gene therapies for hemophilia, cancer, cardiovascular disease and Parkinson's disease.

Cell Genesys's cancer vaccine is made up of tumor cells that have been irradiated and genetically modified to secrete a hormone which plays a key role in stimulating the body's immune response to vaccines. The most advanced clinical trials for this vaccine are nonpatient-specific; the drug could be sold "off the shelf" to any patient. Data announced so far show that the vaccines are safe and result in preliminary evidence of antitumor activity. But these potential products aren't all that are in Cell Genesys' pipeline. The company owns a patent portfolio with more than 220 issued or granted patents, with another 335 pending.

Cor Therapeutics

(CORR) - Get Report

2/15/00 price: $48.72

9/21/99 price $21.75

Market cap: $1.2 billion

Gain since 3/4/99 pick: 124%

It's been a down-and-up month for Cor Therapeutics. First, on Jan. 25, the company released an earnings report that showed slower-than-expected sales of Integrilin, the company's lead product for the treatment of unstable angina and for patients undergoing angioplasty.

The shortfall was only about 6%, but it still hurt the stock. Then, on Feb. 4, the company announced that it was ending its trial to demonstrate the benefits of using Integrilin with stents -- small tubes used to keep blood vessels open in the coronary arteries -- to reduce heart attacks early, because the results were so strong. The drug-stent combination reduced deaths or heart attacks by 50% over stents alone.

The results give Integrilin a huge boost in its battle to gain market share from

Johnson & Johnson's

(JNJ) - Get Report

ReoPro. Thanks to the new data, the two drugs now show comparable benefits, but Integrilin costs just $500 for a 24-hour dose while ReoPro costs about $1,350. Cor Therapeutics is also currently in Phase II trials for Cromafiban, a once-a-day oral anticoagulant. The biggest event for 2000, though, is undoubtedly the expected, country-by-country rollout of Integrilin in Europe.

ICOS

(ICOS)

2/15/00 price: $35.50

9/21/99 price $28.31

Market cap: $1.6 billion

Gain since 9/25/98 pick: 25%

Icos has underperformed the sector recently as everybody waits for what Wall Street has dubbed the "Viagra-killer." IC351 works by inhibiting the production of an enzyme that decreases blood flow -- the same mechanism used by Pfizer's Viagra -- but so far, clinical trials show that IC351 has fewer side effects. (No blue vision, for example.)

The compound went into Phase III trials in the fourth quarter of 1999, and those studies are scheduled for completion around mid-2000. The results -- if positive -- and the filing of a new drug application early in 2001 would send the stock soaring. Icos isn't a one-drug company, however. Instead, it has one of the deepest pipelines in the biotech industry.

LeukArrest is in Phase III trials for the treatment of stroke and the results are likely to be announced early in 2001. Pafase, the first therapy for ARDS (an inflammatory disease of the pulmonary system), is in Phase II trials, with results expected to be announced by mid-2000.

Isis Pharmaceuticals

(ISIP)

2/15/00 price: $11.06

9/21/99 price $12.19

Market cap: $337 million

Loss since 9/25/98 pick: 9%

Isis had a tough December. On Dec. 15 the company announced the disappointing results from its clinical trial of ISIS 2302, a potential drug for the treatment of Crohn's disease. The drug and a placebo were about equally effective in treating the disease. In response, the stock fell from $15.50 on December 14 to $5.59 a day later.

That seemed extreme to me at the time -- in the MarketTalk with Jim Jubak community I recommended buying the stock after that crash -- because ISIS 2302 is by no means the company's only potential drug. ISIS 3521, for the treatment of lung cancer, will go into Phase III clinical trials later this year, and the company is evaluating results from Phase II trials of three other tumor-fighting compounds.

The company also recently signed a deal with

Elan

(ELN)

for the development of ISIS 14803, a drug for the treatment of Hepatitis C that would be delivered using Elan's subcutaneous drug-delivery system, Medipad.

Ligand Pharmaceuticals

(LGND) - Get Report

2/15/00 price: $18.75

9/21/99 price $7.69

Market cap: $901 million

Gain since 9/25/98 pick: 144%

Ligand is on a new-product roll. In 1999 the company received

Food & Drug Administration

approval for three anticancer treatments: Panretin for Kaposi's sarcoma, and Ontak and Targretin for skin lesions related to T-cell lymphoma. As a result, Ligand will spend considerable time and energy gearing up to market and selling these products -- the company's first. I'd expect that effort to keep the company solidly in the red through 2000.

Besides the three products just hitting the market, Ligand has an extremely rich portfolio of partnered compounds now hitting clinical trials: Three are potential treatments for osteoporosis, with partners (Pfizer and

American Home Products

(AHP)

. Another is a treatment for breast cancer, partnered with American Home Products. And one is a treatment for and diabetes, partnered with

Eli Lilly

(LLY) - Get Report

.

Microcide Pharmaceuticals

(MCDE)

2/15/00 price: $17.64

9/21/99 price $6.25

Market cap: $170 million

Gain since 3/4/99 pick: 182%

Microcide is still a way from having products ready for market, but its effort to design drugs that won't trigger resistance in the microorganisms they're intended to fight is starting to move to the clinical-trial stage.

In November, the company announced Phase I clinical trials for RWJ-54428, an antibiotic for fighting bacteria -- like staphylococcus and streptococcus -- that have developed high levels of resistance to the most widely used antibiotics. (Its partner is Johnson & Johnson.) That trial is an important proof of concept for Microcide that demonstrates that the company's approach to drug design has the potential to yield a long list of drug candidates.

Vertex Pharmaceuticals

(VRTX) - Get Report

2/15/00 price: $52 81

9/21/99 price $30.25

Market cap: $1.3 billion

Gain since 9/25/98 pick: 75%

The April 1999 approval from the Food & Drug Administration of Agenerase, the company's drug for treating HIV, was just the most visible sign of progress at Vertex in the last 12 months. In the last six months, Vertex reported data from the Phase II clinical trials of its Hepatitis C drug, started Phase II trials for drugs to treat inflammatory diseases and for rheumatoid arthritis and reported data from its Phase I trial for the next generation of its HIV inhibitor.

Vical

(VICL)

2/15/00 price: $50.88

9/21/99 price $14.38

Market cap: $837 million

Gain since 9/25/98 pick: 254%

Merck, a major Vical partner, began the Phase I trial for Vical's HIV vaccine using the company's naked DNA technology. That announcement got a lot of attention, both because of the huge need for an HIV vaccine and because Merck is attached to the project. But other Vical compounds are actually closer to market.

Allovectin-7 is in Phase III trials for the treatment of malignant melanoma; analysts expect the trial to be complete by the end of 2000. Leuvectin, for kidney and prostate cancer, is in Phase II trials, with data expected in the spring of 2000. Vaxid, a drug to prevent relapse in B-cell lymphoma, is in Phase II trials.

One More for the Portfolio

And now my new biotechnology pick:

Ribozyme Pharmaceuticals

Price 2/15/00: $28.50

Market cap: $320 million

Ribozyme Pharmaceuticals is developing drugs that use ribozymes, a form of RNA, to treat diseases caused when the body overproduces a protein. Targets include Hepatitis C, cancer and HIV.

Ribozyme is about where Vical was a year ago. The company has one compound, Angiozyme, in Phase II trials with

Chiron

(CHIR) - Get Report

that I believe validates the company's basic technology platform. The company recently attracted a big pharmaceutical partner, Eli Lilly, for its Hepatitis C compound. And on Jan. 7, Ribozyme formed a joint venture with Elan to develop Ribozyme's Herzyme for the treatment of breast cancer.

This isn't the only biotechnology portfolio that an investor can build, of course. My low-risk strategy means that, especially now that the sector is hot, I won't be adding any of the high-momentum names such as

Incyte Pharmaceuticals

(INCY) - Get Report

or

Celera Genomics

(CRA)

, two companies specializing in mapping the human genome and then licensing that database to drug companies looking for new targets for their research.

No knock on these companies or their technology. I think mapping the human genome is one of the most significant events in medical history (for good or ill), and I think it will revolutionize the drug industry.

But I also know the history of the biotechnology sector. To say it's volatile is a classic understatement. Prices seem to move to extremes overnight and then correct with violence. I want to be in this sector -- it is where many of the big drugs of tomorrow will come from -- but I don't want to buy stocks that I won't be able to hold onto through the inevitable volatility of this sector.

There's nothing wrong about being conservative when you invest in a sector like this.

Jim Jubak is senior markets editor for MSN MoneyCentral. At time of publication, he was long Icos, Isis, Ligand, Microcide, Vertex and Vical, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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