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The healthcare sector is one that offers both stability and growth. The big and established companies offer stability - people get sick regardless of the state of the economy. On the other side, some smaller development stage biotech companies have huge (sometimes unimaginable) growth potential.

Healthcare's two important attributes

The biopharmaceutical industry is marked by two typical factors:

  • The industry depends largely on blockbuster drugs.

In 2011, 20 top drugs in the U.S. accounted for $319.9 billion. Out of the ten top selling drugs, three belonged to AstraZeneca (AZN) and two to Bristol-Myers Squibb (BMY). And not without reason, the classes of drugs that made the most money were those that were used for preventing/treating the number one killer disease - heart disease.

  • The discoverer/developer is not always the only one that makes the most money either due to lack of adequate funds to carry the discovery further or strategic partnerships - between a startup biotech company and a major drug company or between two major pharmaceuticals.

Pfizer's (PFE) Lipitor, a statin drug that generated $7.7 billion in U.S. sales, actually has its origin in a small Japanese company, Sankyo, where Dr. Akira Endo discovered statins (mevastatin) in 1971 after studying more than 6,000 microbes for an HMG-CoA inhibitor. This prompted other companies to try and discover other drugs in the same class.

Eventually, Merck & Co (MRK) came up with lovastatin and its Mevacor became the U.S.'s first statin drug for lowering LDL cholesterol. Warner Lambert developed atorvastatin and launched Lipitor in partnership with Pfizer in an effort to beat Mevacor to the market. Lipitor went on to become the best selling drug of all times.

The concept was already there and Pfizer made the most of it - Pfizer eventually acquired Warner Lambert in 2000.

Sanofi (SNY) developed and got FDA approval for clopidogrel bisulfate (Trade name Plavix), a blood thinner, in 1997. Plavix has been a top selling drug for years with U.S. sales worth $6.8 billion in 2011. The drug made money not only for Sanofi but also for Bristol-Myers Squibb as a result of a strategic partnership between the two biggies.

The point I am trying to emphasize is that investors looking for the next blockbuster drug would have to broaden their search and include smaller biotech companies, including the not-so-popular, along with the Big Pharma. And investors wanting to build a portfolio of pharmaceutical stocks need to strike a balance between the biggies and the speculative biotech companies.

The big ones

The big healthcare companies like Johnson & Johnson (JNJ), Pfizer and GlaxoSmithKline (GSK) are basically groups of diverse companies or segments under common ownership and run as a single organization. These offer stability as they are not based on a single drug. Johnson & Johnson, for example, is a highly diversified company with more than 250 subsidiaries with operations in 60 countries selling a wide range of healthcare consumer healthcare products - from Band Aid to Tylenol - and medical devices and diagnostics.

These are multiple product companies and a single drug forms just a small part of overall revenue. At the same time, failure of a pipeline product does not have a major impact as the expected revenue is only a miniscule portion of overall valuation of the company. For that matter, even patent expiration has failed to have a major impact.

Johnson & Johnson lost patents on a few of its top selling drugs in 2011 and 2012 - Concerta, Levaquin and Invega - that had combined sales in the region of $2.5 billion. In 2013, the company loses patents on Aciphex and Procrit and may suffer a revenue loss of roughly $3 billion.

These are small figures for a company that had total net annual revenue amounting to $67.23 billion in FY 2012. Moreover the company's drug for use in mantel cell lymphoma and multiple myeloma, Velcade, achieved blockbuster status in 2011. But the company faces further challenges in 2014 when Velcade and J&J's other blockbuster drug ($5 billion sales in 2011), Remicade, (infliximab), a monoclonal antibody for treatment of Crohn's Disease and rheumatoid arthritis, go off patent.

However, the company recently got approval for Invokana (canagliflozin), for lowering blood sugar levels in patients with Type 2 diabetes. Invokana is the first in its class (inhibitor of subtype 2 sodium-glucose transport protein -SGLT2) of drugs to be approved and along with Zytiga, which received priority review status for larger use, is expected to offset the revenue loss from patent expirations.

The high-risk-high-reward space

The best part is that one is spoiled for choices here; the con part is that the unknown can be just as risky as it can be rewarding. No amount of caveats and warnings should be enough for investors in this space. This is the space of opportunities and of huge losses. With that caveat in mind, AtheroNova Inc. (OTCQB:AHRO) is an interesting bet. The company has chosen to approach the treatment of atherosclerotic plaque differently. Its leading candidate for heart disease, AHRO-001 makes use of bile salts that occur naturally in the digestive tract for dissolving soft or vulnerable plaque. It is an old concept as bile salts have been under the microscope since long and one chemically synthesized metabolic byproduct of intestinal bacteria, Ursodiol (Ursodeoxycholic acid) has already been approved by the FDA for treatment of gallstones and biliary cirrhosis.

Bile salts for treatment of atherosclerotic plaque represent a new class of drugs that, if approved, can potentially complement the $20 billion market for statins.

Sarepta Therapeutics Inc (SRPT) is another company that investors could look at for playing in the speculative biotech space. The company's experimental drug, Eteplirsen, for some mutations which cause Duchenne muscular dystrophy (DMD), a genetic degenerative muscle disease is currently in clinical trials. Results of a small study reveal that the drug helps boys with DMD to walk further. On April 15, 2013, the company announced that the FDA will consider accelerated approval for eteplirsen.

Potential growth

Investors may also look at biotech companies that have an established potential for growth keeping in mind that this is also a speculative investment. Vivus ( VVUS) for example failed to effectively market its weight management offering, Qsymia. Dendreon (DNDN) is a provider of advanced prostate cancer treatment. Both companies could do well if they were to find an experienced marketing partner.

On the other side, there are billion dollar companies like Amarin (AMRN) whose market cap has dropped simply because their approved offering did not take off as expected. Amarin's Vascepa was approved for treatment of patients with severe high triglycerides and is in initial stages of launch. On May 30, 2013, the company announced the additional effects of Vascepa on lipoprotein particle concentration. Amarin's stock has lost more than 35% in one year and could be considered for a long haul.

Bottom Line

It is not necessary that you must choose one from each category. The basic idea is to diversify. A speculative biotech is not a good idea for retired individuals or those who hold another growth stock in their portfolio. However, even if you are young, you need to include stocks like Johnson & Johnson or any other large pharmaceutical company for providing stability to your portfolio.

Source: What Must Be In The Ideal Biopharmaceutical Portfolio?