On Aug. 9, the Amex Biotechnology Index (BTK) hit what is likely to be a bottom for the season at 448. If this year is like most years past, investors can expect the sector to rally through September, pause, then rally again from December through February.

Obviously, the rally isn't guaranteed. One need look no further back than 2001 for an exception to the rule. That year, the sector delivered its customary August rally but petered out prematurely on Aug. 27, beginning a decline that lasted until Sept. 24.

But in most years, biotechs decline in the spring as investors anticipate a summer hiatus in the conferences where new clinical results are announced. They rally in the fall as the conference schedule and the volume of news increases. Investing in biotechs now fulfills one of my basic investing tenets: Buy when the playing field is biased in my favor, and avoid it when it isn't.

Three Reasons Now Is the Time

I haven't owned a biotech stock in Jubak's Picks since I sold Icos ( ICOS) on June 10, 2003, and I haven't updated my biotechnology portfolio since 2002. But I think right now is a good time to both buy a biotech (I'll be adding one to Jubak's Picks with this column) and to put together a new version of that biotechnology watch list.

Why? First, seasonality. We're entering the strongest period of the year for biotech stocks. Says who? Yale Hirsch and Jeffrey Hirsch reach that conclusion in their book The Stock Trader's Almanac , as does RealMoney contributor Jon Markman in his book Online Investing .

Second, the sector pulled back from an April 26, 2004, high of 566 on the Amex Biotechnology Index to a low of 448 on Aug. 9 and has since moved up enough to give me confidence that this year has a strong chance of following the seasonal pattern.

Third, big retreats in the prices of some of the sector's leaders make it easier to put together a biotechnology portfolio that balances risk and reward.

Last time around, I argued for building a biotech portfolio by concentrating on companies with pipelines full of promising drug candidates and reducing risk by 1) making sure that these companies had plenty of cash, and 2) buying a basket so that any failures would be balanced out by successes.

This time, I'm advocating a strategy that builds a two-part portfolio with the first group made up of profitable, established biotechnology companies and the second part composed of the kind of pipeline-rich but unprofitable companies in my earlier portfolio.

Time for a New Strategy

Why the change? First, the stock market is different today from what it was two, three or five years ago. Investors are more risk-averse and more likely to want to see results before buying, rather than paying up for potential. That favors profitable, more established companies. Also, these well-established biotechs have retreated from annual highs, which makes them more reasonably priced than they've been in a while, and they are likely to lead any recovery in the sector.

Second, pipelines still pay. The stocks of companies that make the transition from owners of promising drug candidates to owners of promising drugs with Food and Drug Administration approval are likely to show the biggest pop over the next 12 to 18 months if the stock market recovers from its summer doldrums.

That's an important "if" to keep in mind. If investors continue to shy away from equities because they believe stocks are too risky, then biotechnology stocks will not experience a sustained rally.

Now, here's my seven-stock, two-part biotech portfolio for the seasonal rallies.

Group 1: Three Profitable Big-Cap Biotech Leaders

Amgen ( AMGN) is down from its early February 2004 peak near $66, but the stock has been rebounding lately. On the basis of the strength of Amgen's product lineup, I predict compounded annual earnings growth of about 20% through 2005. Using that forecast as well as projected earnings per share of $2.85, Amgen is currently selling for a price-to-earnings/growth rate (PEG) ratio of roughly 1 -- historically cheap for Amgen or any stock with this kind of potential growth. The stock is as cheap as it is for a couple of reasons: Investors fear growth could be trimmed by reduced reimbursement benefits, and while Amgen's pipeline of new drugs looks strong in the short and long term, the middle term is worrisome.

Chiron ( CHIR) is currently trading at just 21 times projected 2005 earnings, but valuation is not the likely catalyst for this stock. Instead, look to the upcoming fall and winter flu season to put a spotlight on this leader in the flu vaccine segment.

Genentech ( DNA) wants to be the world leader in cancer drugs. The company's stock dropped from a peak above $60 in April to $45 at the end of July. In August the stock reversed course, and it appears to be building a base for the rest of the year. Tarceva, a promising lung-cancer drug from Genentech and its partner OSI Pharmaceuticals ( OSIP), is likely to receive FDA approval in late 2004 or early 2005.

Group 2: Four Unprofitable Companies With Potentially Huge Pipelines

Cell Genesys ( CEGE) has a pipeline full of gene-therapy drug candidates for Alzheimer's, Parkinson's and Lou Gehrig's diseases, but the nearer-term payoff comes from the company's GVAX line of cancer drug candidates. I look for the first drug, for prostate cancer, to hit the market in 2008, with drugs for lung and pancreatic cancer to follow by 2011.

Incyte ( INCY) shares have been clobbered after the company took about $50 million in restructuring charges to shut down its Palo Alto facilities. But the company ended its June quarter with about $470 million in cash. That's an important number because it puts an effective floor under the stock near current levels (the company's market capitalization is closer to $500 million). The company is just now moving to clinical trials with its first significant drugs. Its HIV drug has advanced the furthest so far and is in phase II trials.

NPS Pharmaceuticals ( NPSP) is showing signs of life with shares having nudged off the 52-week low of $16.48, about half the 52-week high of $36.61. The timing is just about right since the company is likely to release a bushel of news in the fall. Sensipar (or "Mimpara," as it is known in Europe) for treatment of secondary hyperparathyroidism is likely to get approved in Europe in the fourth quarter of 2004. NPS Pharmaceuticals will present new data on Preos, the company's osteoporosis drug, in an effort to widen the market for the drug in October. And the company is expected to see proof-of-concept results for its new migraine drug by the end of 2004.

Onyx Pharmaceuticals ( ONXX) is valued at $1.3 billion by the stock market, way above its $240 million in cash and cash equivalents and an indication that the company is well along the path that Incyte is just beginning. The company's drug for advanced renal cell cancer is now in Phase III trials, and the company is talking with the FDA about filing for approval based on complete Phase II trials. In addition, Onyx is about to start new trials for its drug for malignant melanoma in early 2005.

Remember, even big-name biotech stocks aren't ones to fall in love with. They're highly volatile and subject to huge seasonal moves. Buy low and sell high is definitely the strategy here. And this season is the time to think about putting it to work.

Changes to Jubak's Picks

Buy Cell Genesys. This is a highly speculative pick. But when you're looking at the seasonal strength of the biotech sector in the fall and the kinds of worries that are bogging down drug stocks, speculative isn't a bad way to go. A small stock like Cell Genesys will get more pop from any move up in the sector than its bigger brethren. And because the company's leading drugs are still years from market, the stock price is driven by research news from the fall wave of medical conferences, not by worries over things like Medicare reimbursement.

Cell Genesys has a pipeline full of gene-therapy drug candidates for Alzheimer's disease, Parkinson's disease and Lou Gehrig's disease. But the nearer-term payoff comes from the company's GVAX line of cancer drug candidates. The first of those, for prostate cancer, is likely to hit the market in 2008, with drugs for lung and pancreatic cancer to follow by 2011. I'm adding the stock to Jubak's Picks with a February 2005 target price of $16 a share.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Cell Genesys to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column. Email Jubak at jjmail@microsoft.com.

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