Seeking Alpha
Peter F. Way, Blockdesk (735 clicks)
ETF investing, CFA, portfolio strategy, long/short equity
Profile| Send Message| ()  

When that health highwayman makes its challenge "your money or your life", few choose to argue. Should it be any different with an investment risk highwayman?

Probably, because your personal health choices may be quite absolute, and few. Not so in investing.

Biotech investment alternatives are legion, and almost universally intriguing, promising, and sometimes mysterious. So the first opinion must be your own. Do all the due diligence your psyche and brain can stand. Don't rush it, and be thorough, since the unseen and the unexpected lurks nearly everywhere.

One caveat right up front: If you are a buy and hold investor, you don't belong here. Go find a box cereal or toothpaste producer and invest in them. Or buy a Powerball ticket, which is another game where it takes hundreds of thousands, even millions, of unwitting risk-takers to feed the winners.

We regularly read about the "big score" nameplate investment that made the celebrity venture capitalist famous and rich because he still owns scads of it. But you rarely hear of the thousands of gone-bust items it took to get him there - or afterwards. Successful VC's know when to fold 'em. Buy and hold is their exception, not their game, nor should it be yours in the high-risk world of biotech development.

That is one good reason every knowledgeable investor needs a second opinion when it comes to biotech stocks. What often kills these companies is they run out of the ability to attract the life-blood cash capital it takes to get products to the revenue-capturing stage. Don't let your portfolio fall victim to a similar kind of condition.

Learning about the medical/health world and its intricacies is a major undertaking. So it may be easy to lose sight of the need to bring in another specialist when the diagnosis turns from the healthcare issues to financialcare ones.

Biotech stocks are just one therapy, and potentially a very good one among others, for an investment portfolio. But beware of the need to make comparisons with alternative treatment avenues. First, comparing alternatives within the biotech investment community, and then outside, with parallels in other high-tech neighborhoods.

What is needed is a very broad-gauged specialist, one who can help guide your choices along this maze of decisions in a way that fits your financial body's particular chemistry. But the controlling factors should now switch from traditional physical body vital signs to the essential capital vital signs of risk and reward. High-ranking in the College of Capital Surgeons are the Market-Makers [MMs] who help big-money-fund investors maintain their portfolios' well-being.

Every day they make critical decisions about where to risk their firm's own capital in the process of helping their clients to make money. Often those decisions rest on what it will cost to resist the depredations of the risk highwaymen. Too high a cost will be a deal-breaker, losing some of the revenue that supports their 7-figure annual compensations. Too little protection may cost them their job entirely.

Those motivations sharpen their already advanced skills in weaving Kevlar-like riskproof vests out of investment derivatives for the protection of firm capital. Hedging sciences have their own set of technology advances, and competitive practice thousands of times a day keeps progress coming in that field.

Knowing what the MMs will spend and how the hedges are structured tells what they think the clients may allow or promote as likely ranges of coming prices. Those potentials often subsequently appear because the clients have the money muscle to make it happen.

It's not a perfect science, any more than nanobiology may be, so there needs to be a regularly-updated scorecard kept on the odds for investment profit and its potential size, in every alternative biotech investment of interest. Done well, lots of candidates won't even get an invitation to the portfolio selection competition, let alone get on the short list of favored items.

We systematically determine what the MMs actions are forecasting each day for coming price ranges on hundreds of medical industry stocks and ETFs, along with over 2,000 other similar ways to occupy investment capital. Here is how they see the upside and downside prospects for over 50 biotech stocks and ETFs.

(click to enlarge) (used with permission)

It is apparent that most issues have better upside prospects than downside exposure, while a few are at the diagonal where the outlook is ambivalent. The array of upside potentials is varied, often involving the widening uncertainty of increased downside. That green area contains number references to symbols where the upside is 5 times or more the drawdown exposure foreseen.

Based on how well the MMs have done in the past with forecasts like today's, we know what the odds for profit have been, and how big those net profit payoffs have been, along with the size of the interim stresses of price drawdowns on the way to winning those prizes.

Here is what the scorecard looks like as of Friday, September 27, 2013 for leading biotechs, and for the equity investment population at large:

(click to enlarge)

We have divided these candidates into 3 basic groups: First, the "old reliables" that have forecast histories of at least 3 years or more and records of numerous prior forecasts like today's. They average (on the table's top blue line) profitable experiences in 6 out of 8 or better (76 of 100) of these forecasts.

This group is led by Biogen Idec (BIIB) and Amgen (AMGN), the kind of names regarded by institutions as established, well resourced, and reliable. The first set's 13 stocks and ETFs average an upside outlook of nearly +11% while having experienced worst-case interim drawdowns of less than -7%, for a reward-to risk ratio of 1.6.

The high-tech and developmental nature of this business leads to optimistic expectations, so it is not alarming to find actual net investment profit payoffs averaging only 43% of the upside potentials. As with any average there are outperformers, of which Regeneron Pharmaceuticals (REGN) is notable with an upside promise of +17% met almost completely (84%) by an average net investment payoff of almost +15%. Its accomplishment of those net gains in our time-conservative practice, requiring less than 7 weeks of market days of position holding periods. It has produced payoff rates of annual return of over +180% from compounding those gains over 7 times in a year.

(click to enlarge)

The second group is those 14 stocks with ample prior forecasts like the present, but a shorter than 3-year history to reflect upon. That means a consideration of only one piece of a market cycle, making our observations a bit less reliable. Still, in a rapidly advancing business like this, anything approaching 3 years can be helpful when measured frequently.

Their average upside price prospect is double that of the establishment favorites, as is their net investment payoff accomplishments. Outstanding in this set is Santarus (SNTS), Followed by NPS Pharmaceuticals (NPSP). SNTS has had a steady upward climb for the past two years at an annual rate of +180% to 190%. Those numbers are not a typo or a misprint.

Compared to its Range Index history, a present day investor might not achieve its "ordinary" appreciation in the next 3 months. What a shame to only benefit at perhaps an 80% rate! Its typical max price drawdowns have hurt less than 3%, temporarily, and there have been no 3-month losses from commitments at this RI level.

Analyst SNTS EPS growth estimates for next year fade away from this year's over 300% expectation to a mere +26% for next year. With a past 5-year growth of almost +23%, its present P/E of 18 hardly seems dangerous, even if growth should slow to +10% a year.

(click to enlarge)

The third group of biotech candidates are ones with combinations of either short histories or limited experiences at present Range Index forecast levels. We call them the "lottery ticket" stocks because they could be either losers, or giant winners, due to breakthroughs many are banking on.

Histories of the third group's components illustrate the spectrum of experience potentials. it ranges from a dozen gains at +24% and +16%, to the more losses that show up at -15%. Annual price gain rates run from +975% to -52%. Ten out of 24 in this set have average losses or no performance to record.

These names averaged in the past only ten chances apiece to score, while the rest of all other biotechs show over 90 opportunities each. That makes it hard to achieve conviction to risk capital in these names, even where there has been good performance. In our book these become watch and wait stocks, or the occasional entertainment longshot for "fun money".

(click to enlarge)

Comparing Biotech stocks as a group to the equities population at large is offered in the last few blue rows of the table above. It makes many biotechs out as extremely favorable, with average payoffs of these 51 names at +8.8%, more than double the achievements of the entire gang of 2500. Odds for wins are better, with 2 out of 3, (67%) compared to 5 out of 8 (63%).

Conclusion

Biotechs belong in virtually all portfolios as the odds-on candidates to provide reliable wealth growth, even at today's general market levels. The best of today - (tomorrow's selections may be a bit different) - have demonstrated the capacity to outperform alternative equity investment choices from most other business involvements.

Whether it be BIIB's 19 out of 20 odds for a profit at 7 to 8 times the norm for equity annual rates of gain, or REGN's 9 of 10 odds for gains twice the size of BIIB's, it appears to be the nature of the business to reward investors quite competitively - when they are selective as to choice of price, and of time.

Bigger risks on the odds front (68 wins of 100 instead of 76) can provide +49% annual rates of price returns from the "secondary" biotech set, instead of "only" +28% from the "reliables". Find what works for you; there's good stuff here.

Source: Biotech Investments? Get A Second Opinion