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Only invest in biotech stocks.
Sound crazy? Maybe, but that's what I do. I am not fazed by their high-risk or jaw-dropping volatility. That's because when biotech winners hit, they hit big. Simply put: A basket of carefully selected biotech stocks will trounce the market over the long haul.
The ultimate growth industry
Health care is a sector with a massive demographic tailwind as baby boomers age and spending on drugs and medical devices skyrockets.
Then we have many major advances coming from small-cap biotechs. Due to their small size, a single drug can drive tremendous increases in a company's value. The lengthy and expensive clinical trials required to attain FDA approval serves as a steep barrier to entry, allowing companies that cross this milestone to maintain fat profit margins for many years.
These factors combine to give us an opportunity where explosive returns are to be found.
Growth investors can't afford to ignore biotech
Consider that the top-performing biotechs over the past five years have an average return of 571%. A $10,000 investment in this basket would be worth $67,100 today:
| Company | Return, May 2002 to May 2007 |
|---|---|
| Immucor (Nasdaq: BLUD) | 1,541% |
| Celgene (Nasdaq: CELG) | 1,159% |
| MGI Pharma | 543% |
| Meridian Bioscience | 526% |
| United Therapeutics (Nasdaq: UTHR) | 380% |
| Amylin Pharmaceuticals (Nasdaq: AMLN) | 333% |
| Sepracor (Nasdaq: SEPR) | 327% |
| Ventana Medical Systems (Nasdaq: VMSI) | 318% |
| Dendreon (Nasdaq: DNDN) | 293% |
| Illumina | 290% |
| Average Return | 571% |
Looking at past performance alone does nothing to help us make money now. We need to understand exactly what was creating these monstrous gains if we hope to replicate that performance over the next five years.
To help address that issue, I looked to see if there was a defining characteristic driving the performance of these small-cap biotech companies.
That defining characterisitc
As it turns out, one factor is pervasive in this group: explosive revenue growth due to new product launches. As a group, these companies have a compound annual revenue growth rate of 36.6% over the past five years. This is what happens when a small biotech with no marketed products hits it big with its first drug launch.
Consider Amylin Pharmaceuticals: In 2002, the company had a measly $13 million in revenues. That all changed with the approvals of the company's first-in-class diabetes drugs Symlin and Byetta in 2005. These drugs propelled the company's top line over the $500 million mark in 2006. The company's stock is also up from $9.60 in May 2002 to more than $40 today.
We see a similar pattern at United Therapeutics. This biotech had just $30 million in revenue in 2002, nearly all of which came after the FDA approved its pulmonary arterial hypertension drug Remodulin in May of that year. Since Remodulin's approval, the company has done a great job in delivering top-line growth. Long-term shareholders have been richly rewarded with a stock price that has jumped from $12 to $60.
The Foolish bottom line
The returns above show that, as investors, we want to be there before drug approvals happen if we want to lock in the big gains. This means that we need to find high-quality drugs early in clinical development before their potential is fully recognized by the rest of the market.
As a biotech analyst on the Motley Fool Rule Breakers team, I focus on finding small-cap biotech companies on the verge of releasing new products. More important, I want to find them before anyone else does. If you'd like to take a look at the biotech companies I'm recommending today, click here to join Rule Breakers free for 30 days.
Rule Breakers biotech analyst Charly Travers really does only own shares of biotech companies -- though he doesn't have a position in any company mentioned here. The Motley Fool has a disclosure policy.
