The best ways to profit from the biotech boom

published 30 April 2013

The biotech sector is on a roll.

The Nasdaq Biotechnology index in the US is up by more than 70% (in terms of pounds sterling) over the past two years. That's more than twice the return on the S&P 500 over the same period.

We've been keen on the sector for a while. And anyone who has invested over the last couple of years will have made some very respectable profits.

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But we think there's legs in this boom yet so it's not too late to climb aboard

The key to biotech's latest bull market

As Kopin Tan notes in Barron's magazine, the biotech sector ignited about two years ago after "going nowhere for more than a decade".

What's changed? One factor, Morgan Stanley's Adam Parker tells Tan, is the falling cost of decoding the human genome.

Your genome basically your own individual design blueprint - contains lots of valuable information about the sorts of diseases you might be prone to, and also about how you might react to various treatments.

The genome was first decoded around about the turn of the century. Everyone had been very excited about all the things we would be able to do. Of course, as with all these things (the internet, for example), the market expected too much too soon. In fact, the last biotech bull market ended alongside the popping of the tech bubble, just as the early draft of the genome was being unveiled.

The simple act of decoding the genome didn't mean the entire secret of human biology was instantly unrolled like a red carpet to usher in an era of miracle cures. Good science takes time. And the genome raised a lot more questions than it answered.

It was also expensive and time-consuming to decode. So investors grew bored and disappointed, as high spending on research and development (R&D) didn't instantly yield results.

But now, says Parker, that's all changing. As it gets quicker and cheaper to decode the genome, R&D spending is starting to pay off. One of the big buzz-phrases in healthcare at the moment is the idea of "personalised medicine." The idea is that as it becomes possible for each of us to have our own genomes decoded, medicines and treatments will increasingly be tailored to the specific needs of the individual.

That'll create a new lease of life for the medical industry, with a swathe of new treatments becoming feasible.

Already, the number of treatments approved is rising significantly. In 2012, the number of drugs approved by the US regulator the all-important Food and Drug Agency (FDA) hit a 16-year high.

As Parker puts it, "We could be witnessing a substantial re-rating, where instead of a discount on R&D being embedded into healthcare stocks, a premium could ultimately be awarded for the potential option value of curing a disease."

Translated into English, what he's saying is that investors have gone from thinking: "R&D is a colossal waste of money that these companies could be paying me in dividends"

To thinking: "Wow! This company could make an incredible amount of money by discovering new drugs, and the more money it spends doing so, the better."

If you're thinking gosh, investors are a fickle bunch I'll not disagree with you. That's why markets boom and bust, few more so than rampantly speculative sectors like biotech. But it's also the reason why investing in these sectors can be so profitable when they do happen to take off.

The whole demographic picture also supports the biotech sector, the argument goes. In short, developed world populations are getting older. American baby boomers are retiring in their droves. That means more demand for more treatments.

How to invest in biotech

One way to play the sector is to buy the Biotech Growth Trust (LSE: BIOG) investment trust. We've tipped this one regularly in the past and it's been a good way to get exposure to the biotech bull market. It's up about 120% over the past two years.

It's trading at a small premium to its net asset value of about 1% (in other words, the share price is a little higher than the underlying value of the stocks in its portfolio). But given that the average discount over the past five years is just 5%, and we're in a big bull market, that doesn't seem too unreasonable.

For those who want to invest in individual stocks, it's worth remembering that biotech is a highly speculative area. So if you want to have a hope of making consistent profits, you'll need to do lots of research, and you can't put all your eggs in one basket.

My colleague Tom Bulford focuses on the biotech sector in his newsletter, Red Hot Biotech Alert. If you're at all interested in the sector, find out more about why he firmly believes this invisible' bull market is set to continue.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.