TCS Daily

A Way to Play Biotech

By James K. Glassman - October 9, 2000 12:00 AM

There's no doubt that biotechnology holds amazing promise in the fightagainst human suffering and disease. And the financial possibilities seem almost as promising. When you consider that all diseases have some genetic basis, it seems clear that big rewards await those companies that can use our new knowledge of the human genome to cure human illness.

The problem with biotechs has always been figuring out how to invest in this volatile sector. On the one hand, investing in a particular company with an exciting new therapy is extremely risky. Unless you have a Ph.D. in molecular biology, it's very difficult to assess the value of the firm's technology. And you can't judge the company on its financial performance, either, because biotechs typically lose millions for years while they're developing a drug, testing it, and then awaiting FDA approval. Unpredictable doesn't begin to cover it. You have to wait years before you even know whether they'll have a product on the market.

On the other hand, you could invest in large pharmaceutical firms that have licensed biotechnology or developed some of their own. But while this approach limits your downside - Merck is probably going to be in business next year - it obviously limits your upside, too. Even a fairly big hit in biotech could almost get lost in Merck's revenues.

The natural solution is to own a biotech fund. In the past I've recommended a variation on this theme - owning shares in Merrill Lynch's Biotech HOLDRs trust (Ticker symbol: BBH). HOLDRs are like mutual funds except the HOLDRs trade like stocks, the expenses are lower, and for a small fee the owner can take possession of the shares of the individual stocks in the trust. I still like BBH - by offering stakes in the largest, most profitable biotech firms, it provides a great way to invest in biotech for the long term.

But let's say that you really enjoy picking stocks and following specific companies. Or maybe you believe in the future of biotech, but you think that the current kings of the hill are overpriced and past their primes. Maybe you think that the greatest discoveries are likely to come from people and companies that we haven't even heard of yet. Well, another way to play the biotech age is to follow the strategy that has worked well for many investors in the Internet age. Don't buy stock in the gold miners - invest in the guys selling picks and shovels. Unsure about Amazon's business plan? Invest in Sun Microsystems or Microsoft, which make the hardware and software behind the dot-coms.

In a similar way, if you're not sure which company will cure cancer, invest in the people who provide equipment to those searching for cures. PE Biosystems Corp. (PEB) makes the gene sequencing machines that allow sister company PE Celera (CRA) to map the human genome. Waters Corporation (WAT) is a leader in liquid chromatography, which allows scientists to analyze the chemical content of a given substance - very useful in biotech labs.

You also might consider Agilent Technologies (A), which carries a very reasonable price/earnings ratio of 32. George Gilder likes Agilent for its innovations in fiber optics. You might like Agilent, the former testing and measurement division of Hewlett-Packard, for its medical lab equipment business. This company has solid revenue growth and may be ready for a rally after falling from a high of $162 per share all the way to a recent $49.

For more aggressive investors looking to accept a good deal of risk, there are three small, money-losing companies at the forefront of a very high-tech industry - making computer chips that analyze genetic material. All three have been punished of late by investors, but Affymetrix (AFFX), Caliper Technologies (CALP) and Nanogen (NGEN) seem to be in the right business at the right time.

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