By Karl Thiel (Fool.com, July 20, 2006)
Biotech can be one of the most lucrative areas of the market. Unfortunately, it can also be one of the most confusing. Here are a few keys to find market-beating biotech investments.
I'm a biotech investor. And I know what you're thinking: too risky. While it's true that some folks treat biotech investing like gambling -- blindly placing their hard-earned dollars on the 50/50 outcome of one clinical trial or regulatory decision -- that would be more risk than I can stomach. There are ways to identify better biotech opportunities -- such as the ones that have made Amgen (Nasdaq: AMGN) and Genentech (NYSE: DNA) some of the best-performing investments of the past decade.
I know because I'm a member of the Motley Fool Rule Breakers team, where we have recommended eight biotech companies to subscribers since inception nearly two years ago. Despite a brutal environment for biotech stocks in 2006, the average return of our biotech portfolio is up 10.5% -- versus 3.5% for the S&P 500 over the same period. Not every pick is in the black, but we've been able to find some stellar performers that have made the risk worthwhile.
I'm not trying to hog any glory here, but I think there's a reason our team has been so successful. We share a common goal of finding companies for subscribers that won't just pop for a day, but rise for years to come. Here are three of the critical factors we seek when looking for long-term biotech winners:
1. Management, management, management
A lot of amateur biotech investors think that a company will succeed or fail based on the quality of its drugs. That's only partly true. More important than great science is great management.
Why? Because getting a drug to market isn't simply a matter of putting it through the "right" clinical trial for the "right" indication, and then waiting out the results. Compounds don't come out of a test tube with a little tag that says "potential blockbuster for disease X." Choosing the best indication, establishing the optimum dosage, and determining how much to dedicate to phase 2 refinement calls for a balancing act of financial resources, market evaluation, personnel allocation, and scientific analysis that only great management can make happen.
Take thalidomide, which was tragically miscast as a safe treatment for morning sickness when it was first introduced in 1957. The drug found new life when Celgene (Nasdaq: CELG) licensed new rights to the product and began developing it for AIDS-related wasting syndrome in 1992. That market all but disappeared when new HIV protease inhibitors were developed, but Celgene completed a 1999 study showing that thalidomide effectively treats multiple myeloma. Celgene's management turned a decades-old horror story into a newly proprietary product that racked up about $388 million in 2005 sales. In 50 years, the biology of thalidomide didn't change. Savvy entrepreneurs just perceived new opportunity.
2. Focus on phase 2
Casual biotech investors know the basic steps a drug takes along the path of development -- from lead compound to preclinical testing (in the lab and later in animals), then through phase 1, 2, and 3 clinical testing, and finally to an approval decision.
Most investors also know that a phase 3 study can make or break an investment. The fortunes of a product typically rest on two -- or sometimes even just one -- of these large, expensive studies. Phase 3 is truly where headlines are made. At the other end of the clinical spectrum, phase 1 trials are designed to weed out drugs that have noxious side effects, poor pharmacokinetics, and the like.
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