Investing in biotech stocks is not for the faint of heart.
Not only is the science challenging, but often the best performing stocks make no sense on commonly-used valuation metrics. Instead, huge price swings occur on the basis of "news flow" of the progress of new innovative drugs and therapies.
As the chart above shows, biotech stocks have been huge winners this year. Companies like Gilead Sciences and Celgene have nearly doubled in the wake of investor enthusiasm for not only their new drug innovations but also the large potential increase in patient usage.
In addition, biotech stocks are probably the only true growth area left in the health care space. If your mandate is to invest in growth stocks, biotech is essentially the only way to go.
I went to hear biotech analysts Joel Sendek and Steve Willey from the brokerage firm Stifel Nicolaus yesterday.
Joel and Steve think that there are more gains to come from the biotech space, but future returns will vary widely, as would be expected.
Since most of their stocks do not yet make any money - which is fairly typical in the biotech world - their views are largely based on their opinion of which companies have drugs and procedures in their pipelines that seem promising.
Among their favorites are the large cap stocks that have already had great runs: Gilead, Celegene and Biogen Idec. The only large cap biotech stock they don't like is Amgen, which in their view does not have nearly the pipelines as their other large cap brethren.
However, Joel and Steve are true biotech analysts, which means their real passion is finding the next "home run" stock.
They noted the most portfolio managers take a generalist approach to the biotech space. These managers have either a minimal exposure to biotech or focus their attention on the largest stocks. This means that the real opportunities are to be found in the stocks in the small and mid-cap space which are not as widely followed.
Still, most of the smaller cap stocks are true "dream" stocks. Their future price movements are largely predicated on binary events: if their drugs work, the stocks will soar; if not, potential total loss.
For example, one dream stock they currently touting is called Newlink Genetics Corporation (ticker: NLNK). Newlink is focusing on novel immunotherapeutic products that could potentially lead to major improvments in cancer therapy. In trials so far their products have shown great promise, but the final results will not be published until 2015.
Newlink is still losing money, and even if some of their therapies are approved the company will not be profitable until at least 2016.
If they are successful, the stock could go up five times or more before its valuation makes any sense. And if it fails, well, the stock probably goes to zero.
For me, this is too risky, but I am intrigued by some of their large cap ideas.