Investing in Healthcare and Biotechnology Stocks

Rod Raynovich 1/16/2006

Overview

Demand for healthcare products and services will continue to grow, tempered by increased government pricing pressures and shifting of costs to consumers. Moreover, individuals have even higher expectations for higher quality, more intensive treatments due to better medical information and health awareness. Cancer, cardiovascular disease and diabetes have created an ever increasing cost burden to society and new treatment alternatives offer significant benefit to patients while reducing costs. In addition the following diseases are of high incidence and will see new products for cost effective treatment: CNS, Infectious Diseases, and Musculoskeletal/Pain. Another technology trend is the convergence of drug, diagnostic and delivery technologies as seen with cardiovascular stents and pharmacogenomics (targeted therapy).

A major investment consideration in is choosing among several sectors such as products/diseases, pharma/biotech, services and research tools. Within these categories there are subsectors like diagnostics, CRO’s, breakthrough discovery tools and new biology such as stem cells.

2005 Results

The past year was another excellent year for the biotechnology sector with the large cap Exchange Traded Fund BBH fig.1 up 40% and many large cap biotechs up big as follows: AMGN up 23%, DNA up 70%, CELG up 144%, CHIR up 33%, GENZ up 22%, and MEDI up 29%, while the broader and the broader cap ETF- IBB lagged significantly up only 2.73%. Big pharma companies such as BMY down 10%, PFE down 13%, and MRK down 1% performed poorly due to regulatory/product issues, patents and limited pipelines.

Large Cap pharma is due for recovery as the stocks offers good value. This is the third year of a bull market in biotechs and the trend is likely to continue in 2006.

European based pharmaceutical companies also did better such as Sanofi-Adventis up 9.6%, Novartis up 3.8% and H. Roche (ROG.VX the big winner up more than 60 %.

Notable among the mid-caps and story stocks the biggest winners were: ABGX up 108%, ALNY up 79%, AMLN up 71%, CBST up 80%, CRXL up 86%, LIFC up 86%,MYOG up 274%, VPHM up 469%, and VRTX up 162%.

Some of these stocks such as MYOG and VRTX are still favored picks of analysts, however many of last year’s mid-cap winners have already exceeded their price targets so they are not likely winners for 2006.

Portfolio Strategies for 2006

Sector and Diversification
Allocation among small cap/large cap, diagnostics and therapeutic products by disease is always an important consideration. There are excellent funds for medical delivery (FSHCX up 29%) that can supplement a biotech portfolio.

Timing
Biotech stocks are extremely volatile and many have already run in 2005. Buying on dips is an excellent strategy given the long term trends for the industry. Review the trend for your stock or for BBH and you might conclude that early Q2 is a good entry point for a long trend buy program because seasonality is weak in Q1. Q4 is strongest.

Products and News
If you chose Phase III products for Cancer and Diabetes as a focus you might have bought ABGX, AMLN, DNA and CELG. Generally good clinical development news for Phase II and Phase III products drive stocks and last year Phase I results even drove VRTX.

Drivers for 2006

M&A: Mergers and big pharma buying biotechs e.g. PFE bought Vicuron
Product innovation, patents and approvals
New themes like “personal medicine”
Caveat Emptor: Potential equity financings in the range of $9 bln. could create an oversupply of stock in the sector.

Top Picks – (Service Cos. Excluded – See FSHCX above)

Core Position: 70% large cap and ETF’s, 30% small and mid-cap.
BBH 40% of total, IBB 10% of total = 50%.
Balance of portfolio and buy on weakness: 35%

• AMGN
• BIIB
• CELG
• GILD
• GPRO
• PFE
• WYE

Speculative Positions: 15% Total

• AXCA
• EPIX
• EXEL
• GLGC
• IMCL
• IDIX
• MEDX
• ZGEN

Large Cap diversified healthcare and device cos such as ABT, ACL, AGN, BSX, CAH, JNJ, STJ were not in consideration. One can participate in these in mutual funds such as FSMEX and FSPHX.

Stocks to avoid or Underweight

Our position here is to avoid stocks that have become too pricey due to speculative frenzies, valuation (price to sales and price to cash) or that be may be already extensively owned.

• ABI/CRA
• DNA
• MYOG
• VPHM
• VRTX