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Is Buying Biotech Stocks a Good Idea?

Buying biotech stocks seems like a contrarian play at the moment. But it made one day trader a lot of money. Here’s what it says about the current market.

Biotech Medtech Stocks

Birthday parties for three-year-olds are a strange place to talk stocks. But that’s exactly what I did over the weekend with another dad, a day trader who said he’s made a killing buying biotech stocks.

More specifically, this trader and father of a one-year-old said he’s had some luck with small, start-up pharmaceuticals. Given that small-cap pharma stocks aren’t necessarily my area of investing expertise, I was fascinated—and somewhat surprised. After all, biotech stocks as a group have struggled a bit of late. The iShares Nasdaq Biotechnology ETF (IBB), which counts Regeneron Pharmaceuticals (REGN), Vertex Pharmaceuticals (VRTX) and Alexion Pharmaceuticals (ALXN) among its 99 holdings, tumbled recently, falling from a high of 113 in early October to as low as 101 in mid-November.

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The IBB has since recovered to 106, and is still up 20% year to date. But with the Nasdaq up 25% in 2017, buying biotech stocks (small or large) seemed like a bit of a contrarian way to make money these days. Or is it?

For an answer, I turned to Tyler Laundon, editor of our Cabot Small-Cap Confidential advisory and someone who is much more knowledgeable about biotechs. Here was his take:

“I think (biotech stocks) are looking better and better. Acquisition activity (starting with Gilead Sciences (GILD)) combined with a big correction seems to have reset the clock, so to speak. And I think investor enthusiasm is coming back gradually. We’re seeing some strength in small-cap biotech stocks, which seems constructive.

“What to look for (when investing in biotechs) is always very stock specific. But at a high level, the chart is always very important. Then a mode of action for the drug that appears likely to work, either through company-specific trials or trials from others. It’s always nice if you can envision the company as an acquisition target for another company that likes the pipeline potential. It’s also nice to see some collaboration with a more established player since I can only understand basic level medicine, at best! And lastly, I don’t want to wait years for one trial result—I tend to like a company more if it has potential approval for a drug candidate within 24 months.”

Though Tyler doesn’t currently have any biotech stocks in his Cabot Small-Cap Confidential advisory, that could change if the sector’s recovery starts to pick up steam. That said, my interaction with a day-trading pharma-stock bull speaks to a larger point about the current investing climate.

With sector rotation in full swing, you never know from week to week what will be the hot sector. Last week, retail stocks, financial stocks and certain commodities got a nice bump, while large-cap tech stocks struggled. This week, the investing winds could shift to other sectors entirely. Thus, winning stocks could come from just about anywhere, and buying biotech stocks is as good an idea as any—just so long as you pick the right stocks! As our resident growth investing expert Mike Cintolo advised his subscribers late last week, you should “take things on a stock-by-stock basis.”

Despite some recent turbulence, opportunities for big winners abound. And you should leave no stone unturned in searching for them.

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Chris Preston is Cabot Wealth Network’s Vice President of Content and Chief Analyst of Cabot Stock of the Week.