Three Ways to Get Rich in the Market's Most Volatile Sector

In 2002, Alkermes thought it had a winner on its hands...

The small biotech and its Big Pharma partner, Johnson & Johnson, had developed the drug Risperdal Consta to combat schizophrenia. It was a great deal for a while... The market assumed the drug would be approved by the FDA the first time around.

But on July 1, 2002, the FDA issued told Alkermes it wasn't ready to approve the drug. The agency wanted some data reanalyzed and repackaged. Investors panicked. Alkermes stock dropped from $16.01 to $5.15 in one day. Shareholders assumed the drug would face a three- to four-year delay.

Wrong.

On April 29, 2003, J&J submitted additional data, and the FDA approved the drug about a year and half later (the drug became a blockbuster in 2007, with more than $1 billion in sales). Alkermes shares soared from roughly $4 to $14 – a 200% gain for investors who bought at the bottom.

The biotech sector sees dozens of similar stories every year...

The stock market is mostly efficient, but occasionally it gets things wrong... and creates a few super-lucrative windows of opportunity. We've discovered a way to take advantage of such rare occurrences with biotech companies, specifically in their dealings with the FDA.

Last year, the FDA approved only 19 new-drug applications, down 10% from 2006. The remaining decisions were "negative responses," which the investing world absolutely hates. In the ensuing frenzy, the market drops stocks 25% on average... without ever bothering to figure out whether they still offer value.

Bottom line is, when the FDA speaks, biotech stocks move, often violently. And I've learned that when stock prices react to such announcements, they create enormous opportunities for folks who know what they're doing...

Here are three ways you can make a fortune from an FDA setback:

1. The "Oops" Factor. Not all drug rejections are created equal. And profits can be made when the market realizes, "Oops, I shouldn't have unloaded the stock without reading the press release first."

For example, in June 2006, the FDA told Pozen that it wasn't ready to approve its migraine drug, Trexima. The stock traded down from $14 to $6 per share. The market wrote off the drug without bothering to find out Pozen's Big Pharma partner, GlaxoSmithKline, had anticipated the setback and was running additional clinical trials to satisfy the agency's concerns.

After six months, the market realized its mistake and sent Pozen back to $18 per share – a quick 200% gain.

2. Pipeline Boost. Positive news from a company's other developmental drugs can get a damaged stock back on the right track. The best example comes from a company called Amylin...

Byetta, the diabetes wonder drug from Amylin, was progressing through early clinical trials when the company received an FDA setback on its lead drug, Symlin. The market was so focused on Symlin's delay that Byetta was forgotten. But as positive news about Byetta's progress through clinical trials trickled out in the next 12 months, Amylin shares made 200%-300% gains.

Today, Symlin generates measly sales around $100 million per year... while Byetta is poised to crack $1 billion.

3. Big Pharma Buyout. Faced with dwindling pipelines, expiring patents, and a fickle FDA, desperate Big Pharma companies simply can't say no to a good, cheap biotech buyout.

At the end of 2006, MGI Pharma received an FDA setback on Saforis, a drug to treat mouth ulcers from chemotherapy. Add on concerns about the stalling growth of its top-selling drug Aloxi at the time, and MGI's stock was hovering near multiyear lows of three times sales. (Similar companies typically trade at seven to nine times sales.)

In December 2007, Eisai, a Japanese pharmaceutical company, offered to buy MGI Pharma for $41 per share cash, about $3.9 billion. That represented an easy double for traders who got in after the initial setback about one year earlier...

As you can see, investing in biotech is much like investing in the precious metals sector.

It is not for the uninformed... and much of an investor's success here depends on contacts and sifting through data. (Click here for one resource I use to track what the FDA is doing in the market.)

The hard work can be well worth your time. Many biotechs have the potential to gain not hundreds, but thousands of percent.

Good investing,

George Huang