When looking for an opportunity, I hope to find a name that has the potential to generate excitement (and hopefully, returns) over a period of time – not over a day, a week, or even a month, but also usually not more than 12-18 months. If I wanted to wait longer, I’d buy a sector-specific index or fund and let those analysts do the work for me. I play because I have fun trying to find a gem and it is a good way of staying on top of the industry.  ‘gotta have some skin in the game, right?

Suffice it to say, that I am not a trader. I have no clue as to how to daytrade, whether it be momentum, quantitative, technical, swing, rap (OK, I made that last one up) or any number of other styles. I do have respect for those traders that perform consistently over time – it’s not easy, and requires a significant amount discipline. I do own mutual funds through retirement plans and such, but only because it is a mindless way of (at least) matching an index and (hopefully) not lose principle.

Short segue here. There is a reason most mutual funds fees can be low (<1.0%, the lower the better in my book) – the portfolio manager just needs to match its index comparator, and hopefully beat it by a few percentage points, their “value add.” Sure, the portfolio manager can change the individual weightings or perhaps add a contrarian idea or two to the fund, in hopes of getting an edge, but as long as they do not underperform their index routinely, you should be in OK for the long haul. If you are paying more and not matching the index at minimum, shouldn’t you find another manager? Ultimately, any reasonably competent mutual fund manger should be able to perform and preserve your investment.

For better returns, there are always hedge funds…the “smart money.”  Those who can and are so inclined, can pay management fees of 2% and give up 20% of the profits in expectation of better returns. It takes work to find a good manager and effort to understand the strategy and risks, but it is certainly worth the effort. The beauty of hedge funds? The ability to “hedge” their bets and protect from losses…in theory; of course, some do use leverage to juice returns as well…lots of leverage. Too bad, I am not an accredited investor…yet (gotta aim high!).

All right. Back to me. Instead of hitting the casinos, I am more comfortable betting on myself to conduct my own research and make an investment decision. Where and how to proceed? As an individual, it means that I am limited in both time and funds to do my homework. I am at a severe disadvantage to the professionals, who have access to a plethora of resources, analysts, and do this full time…as a career. The only way I can have any chance to succeed is to invest in a sector that I know and understand, biotech (hopefully).

I will also need to make concentrated bets in order to generate a return to continue and justify the process. Who wants to study only to simply break even or worse, to lose? Concentrated bets are needed, because if I have $10,000 to play and decide to spread it across 10 companies for diversification/risk management, it gives me 100 shares of a $10 stock. If it goes up 10%, or $1/share, then I have made $100. Taking out the $14 in fees (assuming $7 per transaction), this leaves me with $86, less whatever I would pay with capital gains. If I take a calculated risk and bet on 5 companies instead, I could buy 200 shares of that same $10 stock, doubling my returns.

Better yet, if I can get that same company at $5/share, I can buy 400 shares and increase my chance for greater returns (think Medivation’s ($MDVN) Dimebon failure, followed by MDV3100). So for my own investment game, I need to find companies that are undervalued with potential…aha, just like every other investor out there!

My only edge will be to understand as many companies as possible in order to identify a jewel in the rough, to find the companies people aren’t quite talking about yet, so that I can make a well-researched, concentrated bet, and go in, knowing that an unknown, unknown (Thanks, Mr. Rumsfeld) can pop up and blow my thesis away. Good luck Gilead ($GILD) and Pharmasset ($VRUS)!

With hundreds of publicly traded biotech companies across the globe, how should I whittle them down? First, by size, and by almost default, price per share (PPS). While most folks talk about large, mid, small cap companies, when I think about biotech, it is more about development stages, so to me, there are maybe five, distinct development stages, which is reflected by their valuation (broad strokes; there are always exceptions):

1. Babies: those with valuations <$100 MM, with products in early-mid stage development, usually with a big wart
2. Kids: companies with valuations between $100 – $500 MM, with products in early-mid stage development
3. Tweens: companies with valuation >$500 MM, with products in late stage development and looking to grow up
4. Young Adults: companies with valuations >$1 B, usually a single product, and perhaps, a pipeline
5. Mature: companies >$10 B, with multiple marketed products, exposure to multiple therapeutic areas, research pipeline

At this point, I feel pretty good my decision to continue my focus on biotech and making concentrated bets. But, I will keep an open mind and continue to learn about trading styles and different sectors. In Part II, I’ll look at each development stage.