(AMGN) The Picks and Shovels (and Levi’s) of Biotech

Yesterday marked the 184th birthday of an iconic American businessman – Levi Strauss

My wife worked for Levi Strauss & Co. many years ago. They were a terrific company, with a strong commitment to product quality, their employees and their community. I was so impressed that I remain loyal and almost exclusively buy Levi’s when I need a pair of jeans.

As you may be aware, Levi Strauss struck it rich in the California gold rush. But he wasn’t one of the poor saps wading through the river hoping to find a giant gold nugget. Rather, he sold durable pants to the poor saps.

When Levi Strauss died in 1902, his estate was worth approximately $6 million – roughly $160 million in today’s dollars – likely more than any gold prospector.

His family is now worth many billions of dollars.

Picks, Shovels… and Jeans

Few of the miners actually made any money. The big profits came from people like Strauss who sold the prospectors the tools they needed – the picks, shovels and jeans.

Biotech can be a similarly treacherous field. Great fortunes have been made by investors who metaphorically found gold in the river and picked the right biotech stock. Early shareholders of Amgen (Nasdaq: AMGN), Celgene (Nasdaq: CELG) and Biogen (Nasdaq: BIIB) have enjoyed huge profits as their investments have climbed from penny stock status to blue chips near or above $100 per share.

And there are plenty of exciting and promising small cap biotech stocks out there. Some have made incredible advances against difficult-to-treat diseases. Hopefully, in the near future, shareholders will be rewarded as patients’ lives are improved.

Though I recommend biotech stocks, an area that I really love is the companies that provide the “picks, shovels and Levi’s” to the drug and biotech companies. The companies that sell the tools necessary to conduct research make money regardless of whether the drug is successful.

A Few Examples

Most of these companies are profitable, with positive cash flow. That contrasts with some of the small cap biotech companies that don’t even have revenue yet. These “picks and shovels” companies are a way to play the biotech space while still investing in a real business.

For example, Qiagen (Nasdaq: QGEN) has over 500 products ranging from instrumentation kits to DNA cloning systems.

In 2012, it made $1.25 billion in profits or $1.08 per share. It generated $245 million in cash from operations.

Sigma-Aldrich (Nasdaq: SIAL) has 1.3 million customers around the world serving them with 187,000 products like organic chemicals, proteins and human cell lines.

Sigma-Aldrich generates over half a billion in cash flow and $2.6 billion in revenue.

Then there are the DNA sequencing companies like Illumina (Nasdaq: ILMN) and Life Technologies (Nasdaq: LIFE). The companies provide the machines that read DNA. Right now we’re only able to analyze a small fraction of the data that can be collected.

It is expected that within 10 years, every cancer patient will have the DNA from his or her tumor sequenced. Think about how much more knowledge we’ll have about cancer if we’re able to read and understand the DNA from every cancer tumor. Breakthroughs like that are what will likely lead to more effective medicines or perhaps someday even a cure.

Both companies are profitable.

Waters Corp. (NYSE: WAT) also has a wide range of products including peptide separation technologies, metabolite identification systems and even software for analyzing herbal medicines.

Waters generated $1.8 billion in sales in 2012 and nearly half a billion in profit.

There are many ways to strike it rich in the biotech sector. You can get lucky and invest in a small cap company that becomes the next Biogen, or you can act like Levi Strauss and make your money by supplying the speculators with the tools they need.

If you want to invest in a booming sector fueled by an aging population that will demand new therapies, yet be sure your money is going into a business and not a lottery ticket, look at the medical tools and services companies.

If Levi Strauss were alive today, I bet he’d be supplying the biotech sector with innovative gear like he did to the gold miners 150 years ago. Strauss not only made a successful product, he created a template for how to make a fortune off others’ speculation.

Good Investing,

Marc

Editor’s Note: Four years in the making, Marc is finally ready to pull the trigger on what he thinks could be one of his most profitable trades to date. We’re talking about one of, if not, the greatest advancement in medicine in the past 150 years. It will completely change the way new drugs are discovered and even created – along with the lives of early investors.

For the full story on this incredible breakthrough Marc calls “Cures on Demand,” click here.

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