INVESTING: Explore biotech universe, but choose selectively

If you look at stock market returns over a 100-year-plus time frame, the highestreturning industries have been pharmaceuticals and cosmetics. Dropping the time frame down to the last 25 years shows a different picture, with technology taking the top spot. But with more than a century of momentum, drug companies can still attract interest.

Using a quantitative screen that I run every week, I noticed that biotechnology stocks have been picking up steam lately. This surprised me because the big pharma stocks have been at best market performers for several months. I was even more surprised when I looked at the two main exchange-traded funds in the group, BBH and IBB, and observed very different levels of performance. IBB recently broke out to an all-time high, while BBH is 8 percent below a new high. That wasn’t the end of the surprises, however.

Exchange-traded funds are only as good (or bad) as the stocks that are in them. A majority of ETFs are capitalizationweighted, meaning the more valuable the stock, the more it has the ability to move the ETF. As I watched IBB move to a new high, I remembered that Amgen, one of the biggest biotechnology companies around, is the highest-weighted stock in the ETF. I think it’s trying to redefine what long-term down trend really means. I wondered how the ETF can do so well with its largest component stinking up the joint. Obviously, there must be other stocks in the index that are compensating.

When tearing into the biotech universe, you see that it is not just a case of the big stock doing poorly and everything else lighting it up. There is (like so many other areas of the market) a degree of selectivity. Biogen Idec has been in a solid uptrend since March. Gilead Pharmaceuticals and Teva also have been solid contributors. But the stock that intrigues me most is Amylin. It is the second-highest-weighted stock in the index, and it has been building a base since early June. Its main business is a diabetes drug sold through a partnership with our own Eli Lilly and Co. The drug, Byetta, has shown clear advantages over the competition, namely the possibility of helping patients with weight loss. There is the possibility that Lilly will take Amylin over just as it did ICOS, the company that helped it produce Cialis.

The blueprint of a big pharma company’s buying a smaller biotech research partner should pop up more often in the next few years. Perhaps that is one reason some biotech stocks are moving higher. Another possibility behind the improving stocks could be related to the political landscape. Democrats have talked about increasing funding for stem cell research. That will hit the biotech world right in the bottom line, in a good way. The success and failure of biotech stocks often is left to the whims of a governing body, which carries high levels of risk. But there seems to be enough going on to warrant at least some legwork. A smaller-than-average investment could go a long way in this sector.