August 12, 2009 - Biotechs are fascinating. They have such great promise, yet very few of them actually turn those promises into money. Cures for all types of cancers always seem imminent with promising (there's that word again) results from mice or small control groups. Phase I testing is completed and all kinds of good stuff seems possible. Then something usually happens. Usually not very good things.

So should investors just ignore this potentially lucrative part of the stock market? No way. If you were lucky enough to have owned Dendreon when it rocketed from $5 to $25, you know the thrill of the ride. But that doesn't happen very often. In fact, many take the ride up and just as quickly crash and burn, never to be heard from again except for a few PR releases that try to generate new interest. Rarely happens. When a biotech goes out of favor, it won't regain interest until an actual product is delivered. Investors won't buy the promise story more than once from the same company, but they'll buy it over and over from new ones all the time.

Investors have to approach biotechs the way all mutual funds that specialize in them do: they have admit they don't know what will happen and not bet the farm on any one stock. Here's the way to buy these volatile and rewarding stocks.

Don't get excited. Of course, this is the hardest part, especially when there seems to be a breakthrough and initial responses are very positive. Then a biotech stock will usually have a real spurt. Horizons seem limitless. Potential profits seem enormous. But they rarely are. These early bloomers quickly fade as investors step back and realize that maybe there will be a much longer time frame before the cure is monetized. Then these same euphoric investors become sellers, and the stock heads lower, fast. Don't be one of the euphoric buyers unless the FDA has approved the drug, manufacturing is in place, and the company is ready to send out its products. Of course by then, the stock will be much, much higher than it was years ago as it gained more support with each new positive development. We all want to be in these biotechs before the big news hits to get the greatest returns.

The problem is no one ever knows which one of the promising biotechs will deliver on the promise. A few will but most won't. That's the reality of the sector. Let me repeat that: a few will but most won't. In fact, crochet that into a pillow and put it on the couch as a reminder the next time you feel excited about some news on your favorite biotech.

With that as background, it won't be a big surprise to learn that successful biotech investors always remain cautious in their buying habits. They don't chase sizzling rockets. They are much more comfortable buying at least 5 to 10 biotechs, each with great potential. They buy them a little at a time, on down days, many weeks or months after the initial enthusiasm or news has faded from memory, and early investors have grown tired of waiting for the next step toward fulfillment. That's when biotech investors buy a few hundred shares. Then wait. And if the stock goes lower, they buy a few hundred more. If news comes out to move the stock, they're already in it. Or if the news is so strong that it means orders and revenues and profits, they will buy a little more because the new reality is different. But they don't buy a lot at any one time nor do they concentrate on any one stock.

With so many great breakthroughs seemingly close (see Antigenics or Oncothyreon or Dendreon....all of which I own in small amounts), biotech stocks will make prominent headlines over the next few years. Which ones will be in the news, I can't say, but I know if I buy enough of them and don't put too much money in any one of them, I'll have the best chance of reliving the Dendreon experience.

- Ted Allrich