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The Ultimate Biotech Diversification Strategy

Sunday - 5/26/2013, 10:30pm  ET

You want to invest in biotech. You hear about all the monstrous pops and mini-fortunes that are built overnight. The allure of catching a multibagger is an intoxicating idea -- netting one in your portfolio is even better. Simply put, the biotech industry offers investors something that few other investments can. So no one can blame you for targeting the next big stock.

However, that doesn't mean you get to cheat on the simple rules of investing. My fellow Fools have done an excellent job keeping biotech investors honest recently. Keith Speights laid out a list of pitfalls for beginners to avoid, while Dr. Brian Orelli reminded investors that not every press release is necessarily newsworthy. Today, I want to remind investors that diversity is still important within a biotech-heavy portfolio. Here's my ultimate biotech diversification strategy that focuses on three different kinds of growth.

Don't set sail without an anchor
Every portfolio needs a group of core holdings to weather out storms and net steady long-term gains. Amgen is an easy choice for any biotech portfolio. I was tempted to include Johnson & Johnson for its impressive suite of biologics on the market, but biotech investors may not want hip implants in their portfolio, so we'll stick with Amgen. The $80 billion behemoth has increased its focus in recent years by bringing intriguing compounds into its pipeline, and should have no problem heading higher for the long-term.

Among the positive developments is a new biomanufacturing facility that will be built in Singapore to increase the company's capacity for monoclonal antibody production. That will undoubtedly help with management's plan to go all-in on biosimilars, or generic biologics. Amgen is currently developing biosimilars for blockbusters such as Herceptin in oncology and Humira, Remicade, and Rituxan for autoimmune diseases. The competition will be fierce, but the four drugs alone had 2012 sales of $31 billion. Who better to wrestle market share away from these innovator drugs than Amgen?  

Grab some "easy" growth
Don't chase microcap companies hoping they'll change the world. The market has become pretty good at vetting platforms and pipelines of small companies, so there's probably a good reason for their lowly valuations. There's nothing wrong with taking on some risk, but I believe investors are much better off tackling secure growth. Celgene and Gilead offer just that -- and world-changing potential to boot. Take a look at how they've crushed the market in the past year.

CELG Chart

CELG data by YCharts

They are perfect examples that big market caps don't put an end to growth. Celgene has an astonishing late-stage pipeline and is expecting results from over 10 phase 3 trials in 2013 alone. One promising drug candidate is Apremilast, an oral treatment being investigated in multiple autoimmune studies. While biologics have proved to be a successful option for many patients, they often must be injected. Thus, Apremilast could offer convenience on top of improved efficacy and safety. Data from phase 3 trials completed in 2013 have met primary and secondary endpoints and give investors plenty to look forward to -- and it's just one product candidate in the pipeline.

Gilead is a leader in HIV/AIDS and hepatitis C treatments with a similarly impressive pipeline. And talk about growth: The company increased first-quarter net income 64% from 2012 to 2013. Luckily for investors, things are just getting started. The company's sofosbuvir for hepatitis C could hit megablockbuster status with peak annual sales of $5.8 billion by 2018. Gilead could also see huge revenue from Stribild, a four-in-one combination treatment for HIV treatment, if it can leapfrog other combination treatments in the market. The convenience of taking one pill versus two may help doctors switch patients in the long term.    

Acknowledge the future
When thinking about biotechnology I like to encourage investors to take a big-picture approach that goes beyond pharma. Dozens of industrial biotech companies will produce commercial quantities of chemicals, fuels, fragrances, personal-care products, nutritionals, and more by the end of the decade. Two of the more promising investments currently within reach of investors are Solazyme and Amyris

Solazyme is developing a heterotrophic algae platform for the production of fatty acids in various renewable oil profiles. The company ended March with $239 million in cash and is completing commercial scale facilities on three continents. It will take time to ramp up production, but revenue will skyrocket after going from virtually no capacity this year to 125,000 metric tons of capacity by mid-2015.

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