Biotech Basics: How to Invest in This Healthcare Subsector

By Alison Southwick and Robert Brokamp, CFP Markets Fool.com

In this crossover episode of Motley Fool Answers, Alison Southwick and Robert Brokamp are joined by fellow Motley Fool analyst Kristine Harjes, an avid healthcare sector enthusiast. Kristine is here to help Foolish investors get a handle on a complex but promising business: biotech. Tune in to find out how biotech firms differ from pharmaceuticals, why they're worthwhile investments, the major players, and more.

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A full transcript follows the video.

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This episode was recorded on April 4, 2017

Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by Robert Brokamp, personal finance expert here at The Motley Fool. We've got a special guest in the studio again today. It's Kristine Harjes. She's from Industry Focus, our other Motley Fool podcast. Hi!

Kristine Harjes: Hey, thanks for having me.

Southwick: Thanks for coming. So she's here because she's going to help us do a deep dive into biotech stocks -- how to invest in them, the stocks to watch and more. All that ...and more... on this week's episode on Motley Fool Answers! Whatever! It's fine! Go with it!

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Southwick: It's time for Answers, Answers and today's question comes from Chris, our favorite dairy farmer in Minnesota. I think you like Chris' questions, because you've answered his questions before.

Robert Brokamp: I have, and it didn't occur to me as I was choosing this one, until I had sent it your way, that it was that Chris, but he's got good questions. What can I say? The cows bring it out in you, I guess.

Southwick: Here you go. Chris writes: "Is there any logic behind diversifying brokerages? I purchase stocks, ETFs, and mutual funds through a single brokerage. What would happen if that brokerage failed? I do like the consolidation factor with a single brokerage, but am I missing something?"

Brokamp: Well, Chris, first of all, I agree with you that there's some benefit in keeping a lot of your money with one brokerage. You only get one set of statements. Tax time is easier. Also, the more assets you have with one firm makes you more eligible for many discounts. No annual account fees. If you have a certain amount with a brokerage, they'll allow you maybe access to a CFP or a financial planner, so I think that makes sense. But you also have a good question in terms of what would happen if the brokerage failed.

Well, in would step the SIPC, which stands for the Securities Investor Protection Corporation. A lot of people think of it as like the FDIC for your brokerage. Like the FDIC, the insurance is not paid for by taxpayers but by the member firms. Just about every brokerage is required to have it.

What happens is if the brokerage fails (goes bankrupt or if there is some outright fraud), the SIPC will come in and first get the stuff that's still there (so any of the stocks and bonds that you owned) and move them to another brokerage firm. If for some reason something is missing, they will step in and replace it up to $500,000 and $250,000 worth could be in cash.

Southwick: Do they do this often?

Brokamp: They don't do it that often. They haven't done it in the last few years. The big things that they've had in the last few years are Lehman Brothers, for example, and every one of the account holders at Lehman Brothers got the contents of their accounts back.

The other big one they've been dealing with is Bernie Madoff. There's actually been some controversy, there, because SIPC only has about $2.5 billion in reserves. [That] is not a lot of money when you think of all the hundreds of billions of dollars in brokerage accounts, so there was some controversy about whether it is funded enough for that situation.

Of course, that was a problematic situation, because the whole value of the investment wasn't based on what your Apple stock did or your Disney stock did. You were just trusting that Bernie Madoff was saying that you have an account worth $1 million and you'd just say, "OK, that's fine."

For the average person with an average brokerage account, SIPC, I think, is fine, especially since most brokerage firms also have supplementary insurance on top of that ...

Southwick: Oh, OK ...

Brokamp:... most often from Lloyd's of London. So you can go to your brokerage website and look up how much [of] your account is insured. In the approximately 40-year history of SIPC, there's only been about 350 people who were not completely made whole by the insurance, and [for] most of those folks, it happened in the 1970s when the account limits were lower.

I will say that the insurance just covers stocks, bonds, cash, and typical securities like that. It doesn't cover annuities. It doesn't cover futures contracts. It doesn't cover gold coins or anything like that, so you have to keep that in mind. But for most people, having all of your money with one brokerage account is pretty OK.

I personally would think that once I got to above that limit (like $500,000 or more at the brokerage), I might consider going to another brokerage, if for no other reason than different brokerages have different services. Different access. Different types of research. I might value having those other services.

Southwick: Investments like DRIPs ...

Brokamp: Right, things like that. But for the most part, I think having most of your money with one brokerage is perfectly OK.

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Southwick: So The Motley Fool has a lot of podcasts -- like five. There's Motley Fool Money, Motley Fool Answers, Market Foolery, Rule Breaker Investing, and ...

Brokamp: And Industry Focus.

Southwick: And Industry Focus. So we thought it would be fun to, once a month, invite someone over from Industry Focus to talk about their industry and how best to invest in it. The first person who volunteered is Kristine Harjes, and she covers ... healthcare?

Harjes: Yes, healthcare more broadly and we are going to talk about biotech because why not just dive in headfirst?

Southwick: We could have gone with someone easy like consumer goods or tech but no. Motley Fool Answers listeners, you aren't ready for this, so buckle up, because we're going deep into biotech, yah?

Harjes: Let's do it.

Southwick: First off, though, let's have our listeners get to know you a little bit. Kristine, how did you come to The Motley Fool and how did you become an expert in biotech?

Harjes: I've been at The Motley Fool for about three years. I actually started here as an intern in business intelligence, which is so far removed from what I currently do. So I did that for a little while, and I loved the Fool and all of you wonderful people, here. I had so much fun during the internship and I didn't want to leave, but I knew I was not really suited to be a BI analyst. So I was like, "Where might I be able to slide in and stay in this wonderful place?"

So I ended up on our Fool.com editorial team covering financials and healthcare. I'm not really sure why those were the two that were thrown my way. I don't know. Maybe that's just where the need was.

So I pretty much learned both of those industries from scratch when I started here and loved healthcare -- some find this incredibly boring -- and fortunately had the flexibility to pawn off the financial sector on another intern who became a full-time hire, Gaby Lapera, who now hosts the financials Industry Focus and I just get to focus on healthcare, which is what I love.

Southwick: That's interesting -- that this is what you love.

Harjes: I do.

Southwick: I'm excited to have you come here and share the love of investing in biotech.

Harjes: I can see it on your face.

Southwick: No, I am not skeptical at all. So we're just going to go for it, then.

Harjes: We're saving people's lives. It's an incredibly fascinating industry.

Southwick: Actually, out of all of the healthcare subsectors, biotech is probably the sexiest, right?

Harjes: Oh, big time.

Southwick: Like what does it mean to be a biotech stock?

Harjes: Biotech stocks are the ones that are making the drugs, and you can actually differentiate them from pharmaceutical companies based on the science of how to make the drugs. So pharmaceutical companies make pretty basic drugs. They're called small-molecule drugs. Biotech makes like living-organism-type drugs. They are made with actual biological components, and so those are your biotech drugs that are in development.

A lot of people assume that the whole biopharma world is one amorphous thing, which is kind of true, but technically a biotech works in making biologics.

Southwick: Biologics -- and I'm going to need you to explain that to me. A biologic, then, is different from a regular old drug in that it is ...

Harjes: It's a lot bigger. A type of molecule when you look at the chemical makeup of it. It's a lot harder to produce. Basically the method in which you make it is extremely important, and it's very hard to duplicate, and that's really all you need to know. I'm not a scientist. I am not going to even try to explain how you make these drugs. The thing that you need to know is that they are very complex. It's all about the process and they're hard to duplicate.

Southwick: So why should our listeners consider having biotech in their portfolio?

Harjes: I just think it's fun, so that's reason number one ...

Southwick: Whee!

Harjes:... is that when you start to learn this stuff, it's so cool. It's such a fun industry. It's really interesting to watch. You have the IBB, which is the ETF that tracks the industry. It goes up and down, and up and down. But if you look at the long-term trend, it goes up a lot. If you look over the past five years, the IBB is up 140% and you can compare that to the S&P 500, which is up 68%. So there's another really good reason to have this in your portfolio, because you can generate a lot of returns using biotechs.

Brokamp: Back when I first got into the financial services industry (and this is back in the late 1990s), the big thing was invest to benefit from the aging of the baby boomers. Is that a big part of this, as well?

Harjes: Absolutely, and that is true for the entire healthcare sector, biotech and beyond. There are more people that are living longer, and with that there are more chronic diseases that need to be treated for a longer [period of time]. You just have this demographic tailwind providing a boost for the entire industry.

Southwick: What are some names that ... are there household names? What are some of the bigger names in biotech?

Harjes: Johnson & Johnson is a household name.

Southwick: Oh, yes, I have heard of that, yes.

Harjes: They are not really a biotech. Like they do some biologic drug development, but they also do Band-Aids and stuff like that. But as far as the biotech index goes (the IBB), the biggest components are Amgen, Celgene, Biogen, Gilead Sciences, and Regeneron. So I don't know. You tell me if those are household names. For me they are.

Southwick: They sound like companies from a Terminator movie.

Brokamp: Well, they sound like they're science fiction villains.

Southwick: Yeah!

Harjes: Biogen? Yeah.

Southwick: Like there's something about them where they sound just a little evil ...

Harjes: A little nefarious.

Southwick:... and from the future.

Harjes: You know? I think some people do have the perception that these companies are a little bit evil.

Southwick: Why do you think that is?

Harjes: Because they charge such high prices.

Southwick: For drugs. Yeah.

Harjes: Because they charge such high prices. You've got this miracle hepatitis C cure (I'm looking at you, Gilead Sciences), and you're charging this much money for it. That's absurd. I am more on the side of the industry, here (I think I'm also totally biased just because of what I do), but I tend to believe that they do need to be compensated and have that incentive to continue their development of drugs, because otherwise who's going to find that miraculous cure?

Southwick: Right. So then is the industry -- like Celgene and these companies ... well, Johnson & Johnson, so they're huge. And I guess some subsection of them deals in biotechs. But then companies like Celgene. That's all they do, is focus on them? Then do they have one or two drugs that are huge, or do they have hundreds of drugs that are little?

Harjes: It's somewhere in between. Celgene has like four or five main, big drugs. They also have a much bigger pipeline. Most drugs that you try to develop and bring to market are going to fail, so most companies will always have a lot more that aren't approved yet and a handful (maybe between five, 10, or up to 20) really profit-driving drugs.

Southwick: Well, we brought you here to help us invest like a Fool in biotech, so let's start off with your first piece of advice. If someone wants to look into biotech, what should they know?

Harjes: So this is one that is applicable across any industry, but I think it's especially true in biotech, which is take out your emotions. To the extent that you can, do not get your stomach all tied up in a knot. And actually, if you're somebody that can't avoid having that sort of emotional reaction, this is probably not the industry for you.

You get stocks soaring on news from a super early development trial. You get stocks totally cratering, because they can't market their drugs. It's an extremely volatile industry, and the only way to really make a profit in a Foolish way is to long-term buy and hold these companies.

Southwick: And when you talk about buying and holding these companies, are you talking like the index? Like the IBB? Or like a basket of stuff? Like do you get a bunch to diversify your risk?

Harjes: It depends on what type of investor you are. If you want the least amount of risk while still exposing yourself to this industry, then the IBB is a great way to go. You can also go for one of the bigger, more established players. Or if you're enticed by these potential huge returns, then you can buy just a handful of the ones that you think look the most promising, cross your fingers, and keep following them. It's a risky industry, and you have to understand that, but it also can offer some really phenomenal returns if you choose wisely.

Southwick: Yes, that's the whole thing about risk and returns.

Harjes: That pesky risk, again.

Southwick: Aargh! That relationship!

Harjes: It just doesn't go away!

Southwick: No, it doesn't. All right, what's your next piece of advice for investing in biotechs?

Harjes: The next one that I have for you is follow the big money. What I mean by that is you probably, maybe, demographically speaking, are not a biochemistry Ph.D., so it might be kind of hard to look at what's going on with these drugs and know that it's super promising.

But what you can do is take a cue from other industry experts. Namely, if you look at a small biotech's partnerships with bigger ones, who's getting money? For example, if you look at, say, Ionis ...I know. It's a weird name. You're looking at me like what?

Southwick: It's fine. They're all just like a bunch of syllables smashed together.

Brokamp: You own a what?

Harjes: Their name actually used to be Isis, and they had to change it.

Southwick: Oh, yeah!

Harjes: The stock went from Isis Pharmaceuticals to Ionis Pharmaceuticals.

Brokamp: Did the Greek god sue them? What happened?

Harjes: Bad PR, I guess.

Brokamp: I guess.

Harjes: Anyway, Ionis is a relatively small biotech. I want to say the market cap is like $5 billion or so, and they have a ton of drugs that they're developing. So how do you know if this is a good platform or not? They do have a very unique platform they are using.

Well, they've got partnerships galore. They have one with Biogen, which is one of the big guys that I mentioned where I was listing key components of the IBB. Biogen and Ionis were able to bring the first treatment for spinal muscular atrophy to market, and Biogen paid Ionis a ton of money, basically, to say, "Hey, we think that this drug has a lot of promise. We want to continue giving you money as it develops, and then also we'll give you a royalty on the sales, eventually."

For me, I look at that and I say, "Hey, there's some really smart people at Biogen that like what they see at Ionis. That's a good sign."

Southwick: Then you were thinking invest in Ionis, not necessarily Biogen? Or do you invest in both?

Harjes: It depends on what you're looking to do. Biogen is a more diversified, larger biotech. But if you are trying to figure out whether a relatively up-and-coming company has promise or not, this is one great way that you can get some insider info.

Southwick: And what's your final piece of advice for people looking to invest in biotech?

Harjes: My final thing that you need to keep an eye on, when you're looking at biotech, is cash burn. A lot of these companies are premarket. They haven't actually gotten anything approved yet, but they are spending money galore. They are just leaking millions and millions of dollars trying to develop these drugs.

And so it's really important that you actually pull up the balance sheet. You look at how much cash they have, how quickly they are spending it, and you can do some pretty rough math to figure out a cash runway. How long until they can't even keep the lights on. That is something that, when you're looking at biotech, is important with just about every company, but especially the premarket ones.

Southwick: Before we finish up here, what is a trend to watch in biotech right now?

Harjes: So one trend that I think is worth keeping an eye on is called biosimilars. Earlier in the show we were talking about biologic drugs and how they're super different than small molecule drugs and they're hard to duplicate. So that is where biosimilars come in.

They're a relatively new thing. They're basically the generic version of biologic drugs, which previously did not have generics, because it's so much about the manufacturing process that you can't trust somebody else to just go, "Well, I'm going to whip up the same chemical ingredients and here I have a generic version."

It's completely different, and it's a very new industry. We only have a handful of biosimilars that are approved in the U.S., but it will become a bigger and bigger trend, especially as these biologic drugs start to roll off patent protection.

Southwick: And how about a stock to watch?

Harjes: In biosimilars or in general?

Southwick: Whatever you want. It's your call.

Harjes: In general, I'm going to go with Cara Therapeutics. This is a company that's trying to market a non-addictive opioid-related pain medication. You hear that opioids are this enormous problem. So what Cara Therapeutics is doing is trying to make a painkiller that works, but that doesn't have the feel-good aspects of other opioid medications so that you don't get addicted to it. They're having a lot of success. So far the stock is up 114% just since the beginning of this year.

Southwick: Wow!

Harjes: So people are definitely catching on. There's a lot of buzz around this company, so I'm definitely keeping my eye on them, as well.

Southwick: Awesome. Well, thank you for helping us break down the industry. Do you want to stick around and have some fun with drug names?

Harjes: Let's do it.

Southwick: Let's have some fun with drugs.

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Southwick: One of the most fun aspects of talking about biotech is trying to pronounce the drug names.

Harjes: It's probably my least favorite part of the podcast, actually, because half the time I don't know how to pronounce them.

Southwick: So what we're going to do is we're going to have a little fun. You're going to give us some drug names and we have to try and pronounce them correctly. Then you're going to tell us more about them.

Harjes: OK, I will spell them out for you. Here's number one: Alirocumab.

Brokamp: Well, I love that it has "ali" in the front of it, because it makes me think of you. It's a biosimilar, maybe. So we'll go with all-aru-cumab. All-aru-cumab.

Southwick: That's fine. All-aru-cumab. I'm going to try and put the emphasis on a different syl-lab-ble. Al-i-rok-i-mab.

Harjes: OK, I'll take it.

Brokamp: You have no idea.

Harjes: Here's how I would say it which is Al-i-rok-i-mab, which is basically what you guys said. This is actually the chemical name for Praluent, which is this new type of cholesterol-lowering medication. Kind of a big deal drug as far as drugs go.

Brokamp: Al-i-rok-i-mab. What the heck.

Southwick: Al-i-rok-i-mab.

Brokamp: It doesn't even come close to rolling off the tongue.

Southwick: No, it does not.

Harjes: Ready for the next one?

Southwick: Yes.

Harjes: Number two is -- I almost just said it out loud. I'm going to spell it, now: Niraparib.

Southwick: Ner-rap-er-rib.

Brokamp: Nira-rap-peb. Nir-a-pay-rib.

Harjes: I also actually got pretty set on Ner-rap-er-rib.

Southwick: Yeah! Ner-rap-er-rib.

Harjes: And then I had a fun, little ...

Brokamp: That's a kids TV show. That's not a drug.

Harjes: I was able to find the pronunciation on the internet, which is super helpful.

Southwick: Oh, on the internet.

Harjes: So I can actually confirm that that's what that one is. We actually were just talking about this drug on Industry Focus on last Wednesday, but fortunately it now is approved, so it has a brand name which is Zejula, which I think is a little bit easier to pronounce than Niraparib.

Southwick: That is an alien race which is eventually going to exterminate us all.

Harjes: I have never seen so many z's and j's and x's until working in biotech.

Southwick: All right. Niraparib, also known as za-boom-la.

Brokamp: Za-za-baj-uva.

Harjes: So number three?

Brokamp: Number three.

Harjes: Nusinersen.

Southwick: New-sin-er-sin.

Brokamp: N. The first two letters are silent. Nuggi-ser-ess-sin.

Southwick: New-sin-erin-sin.

Harjes: I go with nu-sin-air-sin with this one.

Southwick: Nu-sin-air-sin.

Harjes: This is actually the drug I was talking about earlier on the show when I was talking about Biogen and Ionis. The SMA drug is this one, Nusinersen. Fun fact about it. It costs $750,000 for the first year of treatment.

Brokamp: What?

Southwick: Huh!

Harjes: And you have to take this drug for your entire life. So after that first year it costs $375,000 annually.

Southwick: Oh!

Brokamp: Holy shaving face.

Harjes: And that's why people hate drug makers.

Southwick: Wow! That's insane.

Brokamp: I understand it costs a lot of money to do these things. Most drugs don't make it. There has to be the economic incentive. It's when you start seeing the executive compensation that you lose sympathy for the companies.

Harjes: Yup, I get that.

Southwick: All right. You have one more for us?

Harjes: Yes, number four. Atorvastatin.

Southwick: Wow! OK! Oh, it's a statin drug.

Brokamp: It's Ator-, ator-va-statin.

Southwick: Ator-, ah, atora-va-statin.

Harjes: It's Atorvastatin, and you correctly identified that it is a statin. This is actually the generic name for Lipitor, which is the best-selling drug of all time.

Southwick: Oh!

Brokamp: Oh, really?

Southwick: So it's not like they just did smash syllables. There actually is like a code, here.

Harjes: There's a little bit of reason to it. For example, the first one, Alirocumab, that ends in "mab." That means it's a monoclonal antibody.

Brokamp: Of course.

Southwick: Of course it does.

Harjes: So there's a little bit of a science, kind of.

Brokamp: What about the x? Because there are a lot of x's in these things?

Harjes: If I had to guess -- you don't really get the X's in the chemical name. You get it in the brand name, and I think that's so you can differentiate the drugs, better, because you don't want a doctor accidentally writing the wrong prescription. Or you don't want the person that fills the prescription to accidentally read the wrong name. It's like an x is a very hard sound, and it makes a word sound different than any other related word.

Southwick: Right.

Brokamp: Maybe it had something to do with aren't prescriptions Rx? Doesn't that mean something?

Southwick: Yours is so much simpler. Let's go with that.

Brokamp: Let's find out what that means.

Rick Engdahl: People in these companies all hated Scrabble. That's why.

Harjes: They're trying to get the most points.

Southwick: Yeah.

Harjes: These were the fantastic Scrabblers.

Southwick: Oh, man. Before you go, leave us with your favorite ... this is something near and dear to Bro's heart. He loves weird side effects apparently. I just learned this about him when we were in the planning meeting for this. So what's your favorite drug side effect?

Harjes: So I think my absolute favorite drug side effect that I've ever heard of is "loss of fingerprints."

Southwick: How does that happen? They're not rubbing off, I assume.

Harjes: I have no idea. I don't think it leaves a mark somewhere, but I'm pretty sure it has to do with your fingers bloating for some water retention issues.

Southwick: Wow!

Harjes: Yeah, super weird. Oh, I have a second favorite one, too.

Southwick: OK, bring it.

Harjes: Which is you might become a compulsive gambler.

Southwick: What is that?

Harjes: I think this is a restless leg syndrome.

Brokamp: It's Mirapex. I have it right here because also increases gambling, sexual, or other overpowering urges and hallucinations may occur.

Southwick: Oh, wow!

Brokamp: So you may be at a party and you may be hallucinating that this person is attracted to you, and then bad things happen. It's very bad.

Southwick: Oh, wow!

Harjes: I also wonder if that's related to the gambling. Like are you hallucinating that you're winning a ton and that's why you keep doing it?

Brokamp: It could be.

Southwick: Oh, wow.

Brokamp: What I just looked up, thanks to Google "why Rx is part of prescriptions." It represents the Latin imperative verb 'recipe' which means take or take thou. There you go.

Southwick: Oh, that's fun.

Brokamp: Yeah.

Southwick: A lot of fun things people are learning. All right, so if you, our listeners, enjoyed learning about biotech, guess what? There's so much more to learn. And so you should start listening to Industry Focus. It's a Motley Fool podcast, and it takes a different sector every day of the week and breaks it down, and biotech/healthcare is on ...

Harjes: Wednesday.

Southwick: Wednesday. You can also listen the other days of the week ...

Harjes: They're OK.

Southwick: They're OK. But if you want more Kristine and learning more about healthcare stocks, I highly recommend subscribing to Industry Focus and paying close attention on Wednesdays. Kristine, thank you for joining us.

Harjes: Thank you so much for having me on. It's been fun.

Southwick: That's the show. I want to thank Brad from Kentucky who sent us a postcard from his trip to Ireland. I love it.

Brokamp: Oh, nice.

Southwick: The cards keep coming, even though I stopped asking for them. But spoiler: I will start asking for them again, come summer. So just know that the postcards make me insanely happy and I want to know where you guys vacation, because you guys vacation in really cool places.

All right. The show is edited biosimilarly by Rick Engdahl.

Brokamp: With no bad side effects.

Southwick: Our email is Answers@Fool.com. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody.

Alison Southwick owns shares of Walt Disney. Kristine Harjes owns shares of Apple, Gilead Sciences, and Johnson & Johnson. Robert Brokamp, CFP owns shares of Johnson & Johnson. The Motley Fool owns shares of and recommends Apple, Biogen, Celgene, Gilead Sciences, Ionis Pharmaceuticals, Johnson & Johnson, and Walt Disney. The Motley Fool has the following options: short June 2017 $70 calls on Gilead Sciences. The Motley Fool has a disclosure policy.