Crash Insurance

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No wonder so few people make money in the stock market. The bogus information, like the nonsense I have been hearing about last week’s plunge, would throw even the savviest of investors off the scent of profits. Sure, China’s market went down and then we went down, but did anyone rewind the tape? We’d been going down pretty steadily for a week before China. And yes, the market melted down on a system overload. Yawn.

No, what’s really happening is that the economy peaked and started heading south in the last quarter of last year. It continues to do so this quarter, and while I don’t think we are headed into a recession, as Alan Greenspan blurted out last week, we have to stop focusing on those companies that do well in a strong U.S. economy and start looking at those that do well in a weak one—the so-called defensive stocks.

Let’s just look at one sector—pharmaceuticals. In the old days, I would have reached for the old standbys, the stocks of companies that I find in my medicine chest (everything there still gets used when we all lose our jobs). But these are not the old days. You can keep hoping that Pfizer will return to its former glory or that Merck will suddenly start doubling and tripling as it did routinely in a previous century. You can pray that Bristol- Myers gets bailed out by a takeover bid, or that Eli Lilly comes up with another miracle drug like Prozac or Zyprexa. Or you can start making money again in the only pharmaceutical stocks that work: the biotechs. Most of the once-great drug companies are now just giant sales forces flogging doctors with various versions of the same old drugs, many of which face imminent expired-patent destruction. And they are public enemy No. 1—worse than oil!—in the new Congress, where the Democrats constantly whine about the need for major drug companies to charge less for their products.

But the biotech companies are all about the future, with potential blockbusters and approvals in front of them, not behind them, and limited competition for most of their current offerings. These companies have pipelines—what drugs really trade on—and trials that could propel them much, much higher than their current levels. Even if an old-line company merges or gets a bid—the only real hope for appreciation—it couldn’t produce the kind of upside that the biotechs give you. Their research bent and their ability to focus on highly specialized, low-profile illnesses keep them out of the crosshairs of the Democrats.

So what’s got the most upside? I’ve got four companies that could have years and years and years of great growth that a Pfizer or a Lilly could only dream of (Genentech, Celgene, Gilead, and Genzyme), a wild-card stock that could get a bid within the next year because of a recent successful cancer trial (Onyx Pharmaceuticals), and two companies (Altus and Exelixis) that are speculation plays. With their promising drugs still in FDA trials, they could either go boom or bust.

Genentech, which some consider to be the first biotech stock ever, has the single most important drug franchise in the world today, the Avastin anti-cancer business. We know cancer’s a bizarre rubric, encompassing all sorts of strains and versions that can’t be cured by one drug. But Avastin has tackled lung cancer more successfully than anything else in a doctor’s arsenal, and now Genentech’s got dozens of tests going on to use the drug on other cancers, many of them showing promising early results. Lately there has been talk that even a little Avastin works so well against cancer that doctors don’t need to use big doses, something that analysts fear could hurt Genentech’s earnings. I say use the weakness this worry has created to buy the company’s shares at a meaningful discount before the next big Avastin success story. Genentech’s not a one-trick pony, and it’s got a new drug, Ocrelizumab, that could be a breakthrough for both rheumatoid arthritis and multiple sclerosis. Ocrelizumab’s full potential seems unknown to Wall Street but could boost DNA, the stock symbol we all know the company by, later in 2007.

Celgene, like Genentech, has invented a drug, Revlimid, meant initially for bone-marrow cancer, that could turn out to be used for many other hard-to-beat types of cancer. Celgene’s running 75 anti-cancer trials for Revlimid worldwide, including one for multiple myeloma that I think could be huge for the stock. Celgene just reported a great quarter, and while the stock has been stalled in the 50s for months, I think now it’s about to break out given the incredible sales of Revlimid last quarter and the potential for some great headlines in the coming year.

Gilead Sciences has an anti-aids franchise that is the envy of every drug company in the world, and it will only get better with the new integrase inhibitor currently working its way through the FDA. Gilead reported the best first quarter of any drug company—biotech or big pharma—because of its anti-aids cocktail. Gilead’s using its stock to buy other companies for a second line of drugs designed to battle hypertension, and its Ambrisentan pulmonary-arterial-hypertension drug just got fast-tracked by the FDA for 2007 review. Gilead’s been the best-performing major biotech for 2007, and I think that streak will continue.

You might have heard a collective shudder from the pharmaceutical industry when the Democrats took Congress. But you would only have heard cheers from the people at Genzyme, the drug company that pursues cures for illnesses that, frankly, simply don’t strike enough people to merit the attention of larger drug companies. The Democrats want research into small-scale illnesses that aren’t economical for bigger companies; that’s Genzyme’s ticket. (You could call it the special-interest drug company for the special-interest party.) The illnesses that Genzyme treats, like Fabry disease and Gaucher’s disease, just aren’t on the large companies’ radar screens. Genzyme has those markets all to itself. Same with its end-stage renal-disease drug, Renagel. With a great mosaic of hundred-million-dollar drugs, instead of one or two big ones that could be knocked out by the competition, Genyzme has ensured itself multiple years of strong growth and earnings.

Biotech companies are all about the future, with potential blockbusters in front of them, not behind them.

Next comes the wild card: Onyx Pharmaceuticals. Here’s a company that just saw its stock double within a week when it revealed that its Nexavar drug can inhibit the spread of liver cancer, one of the deadliest of all cancers, and something for which there is no approved treatment. Many on Wall Street think the stock’s move is too much; I could not disagree more. Liver cancer is so hard to treat and this drug is so unique that I have to believe that Onyx’s partner, Bayer, will want to buy this billion-dollar company just for the liver-cancer franchise. I think Bayer would be willing to pay double the price Onyx fetches now. Given the 18,000 new patients diagnosed with this illness each year in the United States, you could see the drug having $250 million in sales in no time. Even without a deal, you could still have some good upside.

For those who are willing to take some real risk—those who want on-the-move companies without a lot of profits (or none at all)—I’ve got two plays, Altus and Exelixis. These are true speculation ideas, ones that might not pan out at all, or could be home runs. That’s because these companies have drugs that are entering into Phase II or Phase III FDA trials, the last phases before approval. Of course, if the drugs fail, they could be history.

Altus is a drug-enhancement story, with two products that are about to start Phase III, one for cystic fibrosis, and the other for extended-release growth hormone. Drug enhancement means the compounds improve on a current medicine. Altus’s cystic-fibrosis drug allows patients to take pills less often. Altus’s growth-hormone replacement allows patients to take a shot once a week instead of once a day. Both are big-market opportunities.

Exelixis’s drugs are designed to interrupt the growth of cancerous tumors. It has four drugs in Phase lI. Like all experimental drugs, these compounds cost a lot of money to develop, and some of them are bound to fail. But Exelixis partners with Genentech, GlaxoSmithKline, and Bristol-Myers Squibb on these drugs. And if one of the drugs hits big, you could see any of these pharmaceutical giants buying the whole company (like Onyx). That’s why Exelixis has a market cap of almost a billion dollars.

Most people don’t want to part with their old, so-called safe drug stocks, even though they don’t go up anymore and feel more like bonds with a decent yield than stocks that can grow. But it’s time to say good-bye to the old-line drug companies that you’ve been clinging to, and move up to those that are going to make a difference for your portfolio and your kids’ college fund. I would sell any big pharma company and buy any one of these seven stocks. And never mind what happened last week: I would do it today.

James J. Cramer is co-founder of He often buys and sells securities that are the subject of his columns and articles, both before and after they are published, and the positions he takes may change at any time. E-mail:

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