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.