401k Rollover IRA: 401k Retirement Plans’ Booster Rocket, Rollover IRA

Switching your job? Retiring? Congratulations! A window of opportunity opens for you with the Rollover Individual Retirement Account or Rollover IRA.

In an era of corporate restructuring and outsourcing, Rollover IRA is among the most powerful means available for securing one’s retirement. Yet, the potential of Rollover IRA to enhance one’s retirement savings commonly remains under-appreciated.

Rollover IRA widens the range of choices available for investing your retirement savings. By offering investment choices hitherto unavailable in employer-sponsored savings plan like the 401k retirement plan, 403b retirement plan, or Section 457 plan, Rollover IRA provides you the opportunity to more aggressively grow your retirement savings.

This article discusses the advantages of a Rollover IRA as they apply to rollover of retirement savings from employer-sponsored plans. Although the article focuses on the rollover of retirement savings from a 401k retirement plan, the benefits of a Rollover IRA, as discussed here, apply to rollover of assets from other retirement savings plans such as 403b plan and Section 457 plan.

So, if you are leaving your job and have savings stashed away in your employer-sponsored retirement plan, continue reading this article to learn about your options and more.

Four Options for Your 401k Retirement Plan Savings

You have four options on what you can do with your 401k retirement plan savings if you are switching jobs or retiring.

  • Cash your 401k retirement plan savings.
  • Leave your savings in the 401k retirement plan sponsored by your previous employer.
  • Rollover your savings into the 401k retirement plan sponsored by your new employer.
  • Set up a Brokerage Rollover IRA and move your 401k retirement plan savings into the Brokerage Rollover IRA.

Unless you have a pressing need, it is best not to cash your 401k plan savings. First, cash withdrawals from the retirement plan will be subject to federal and state taxes. Second, your retirement savings diminish and you will have fewer assets to grow tax-deferred.

While the three other options will not erode your retirement savings and will allow your 401k plan savings to grow tax-deferred, they are not equal in their ability to help you grow your retirement savings.

Self-Directed Brokerage Rollover IRA Increases Your Investment Choices

Most employees earn meager returns on their employer-sponsored 401k plan savings. A Dalbar study reports that the average 401k plan investor achieved an annual return of just 3.51% during a 20-year period when the S&P 500 returned 12.98% per year.

Part of the problem stems from the fact that most 401k retirement plans offer only a limited number of investment choices. A Columbia University study finds the median number of mutual fund choices in 401k retirement plans to be just 13. The actual number of equity mutual fund investment choices however is less, since the median number includes money market funds, fixed income funds, and balanced funds.

With fewer investment choices, the 401k plan limits your ability to take advantage of different market trends and to continually position your 401k retirement savings in mutual funds with superior risk-reward profiles.

With a Self-Directed Brokerage Rollover IRA set up at one of the large mutual fund companies like Fidelity Investments, T. Rowe Price or Vanguard Group, you will break the shackles imposed by your employer-sponsored 401k plan and dramatically increase the number of mutual funds available for investing your retirement savings. Fidelity, for example, provides access to several thousand mutual funds including more than 175 mutual funds Fidelity manages.

Rollover IRA Mechanics – Fidelity Rollover IRA Illustration

Let’s say you decide to rollover your 401k retirement plan savings to Fidelity. How do you make it happen?

First, set up a Fidelity Rollover IRA. Next, complete the forms required by your current 401k retirement plan administrator and request rollover of assets into the Fidelity Rollover IRA.

You have two choices for moving your retirement savings to your new Fidelity Rollover IRA. One is to elect to have the money transferred directly from your 401k plan to Fidelity. This is called direct rollover. With the indirect rollover alternative, you take the distribution from the 401k retirement plan and then deposit it in the Fidelity Rollover IRA. Unless exceptions apply, you have 60 days to deposit the distribution and qualify for tax-free rollover.

Driving Your Rollover IRA Performance

You need an investment strategy to benefit from the wide range of investment choices available in the Rollover IRA. You can develop the strategy yourself or leverage ideas from investment newsletters to manage your Rollover IRA.

The AlphaProfit Sector Investors’ Newsletter, for example, offers model portfolios that are popular with Fidelity Rollover IRA investors. AlphaProfit chooses Fidelity mutual funds with favorable risk-reward profiles to construct the model portfolios. The Core model portfolio seeks long-term capital appreciation and is a worthy contender for investment dollars allocated to domestic equities within the Fidelity Rollover IRA. The Focus model portfolio is suitable for the aggressive-growth portion of the Fidelity Rollover IRA.

Compound Annual Return from 9/30/03 to 1/31/06

AlphaProfit Focus Model Portfolio36.3%
AlphaProfit Core Model Portfolio21.2%
Dow Jones Wilshire 5000 benchmark15.3%

Let’s say you transfer $50,000 from your 401k retirement plan to the Self-Directed Brokerage Rollover IRA and the wider range of investment choices help you increase your annual return from 8% in the 401k plan to 12% in the Rollover IRA. At the end of 20 years, your Rollover IRA will be worth $482,315, more than double the $233,048 it would be worth if you stayed with the 401k plan. That too without any cash additions to your Rollover IRA.

Adding to Your Rollover IRA

You can leverage the potential of your Self-Directed Brokerage Rollover IRA further by adding to it each time you change jobs. With the Rollover IRA already set-up, all you have to do is to instruct your 401k retirement plan administrator to transfer assets to the Rollover IRA. There is no limit on the amount of money you can transfer.

You may also add money to your Self-Directed Brokerage Rollover IRA through regular annual IRA contributions. They are however subject to the annual limit for IRA contributions.

Summary

When you are switching jobs or retiring, the Rollover IRA opens a window of opportunity for you to widen the investment choices for your retirement assets hitherto not available in the employer-sponsored 401k plan. The Self-Directed Brokerage Rollover IRA empowers you to construct and manage a mutual fund portfolio to boost the growth of your retirement savings.

Energy Conservation: Save Energy Consumption Using Technology

This article originally appeared in The Motley Fool on December 14, 2005.

Technology companies are generally underappreciated as energy conservation plays. By casting a wider net, investors can find appealing situations in the technology space that stand to prosper from the growing emphasis on energy conservation.

Investors typically see oil-related stocks — such as Exxon Mobil (NYSE: XOM) or oil field services giant Schlumberger (NYSE: SLB) — as investment vehicles well-suited for profiting from high prices in oil and gas.

But with oil prices hovering above $50 per barrel, the case for profiting from an increased use of energy-conservation technologies is equally powerful. Investment plays in the energy-conservation space are available in all of the major sectors of energy usage — transportation, industrial, commercial, and residential.

In the transportation space, the appeal of Honda (NYSE: HMC) and Toyota (NYSE: TM), who make the fuel-efficient Insight and Prius models, respectively, is obvious. So, too, is the appeal of companies such as Energy Conversion Devices (Nasdaq: ENER), whose nickel-metal hydride batteries have the prospect of being increasingly adopted in hybrid cars. Investors have caught on to shares of Energy Conversion and bid its price up by about 45% over the past year.

Although more than 70% of the energy consumed in the U.S. falls in the industrial, commercial, and residential sectors, not many companies that focus their efforts on improving the energy efficiency in these sectors have received significant investor attention. Investors willing to cast a wider net on energy conservation can find some seasoned yet underappreciated companies in the technology space.

The proven impact: power semiconductors

Chip manufacturers such as National Semiconductor (NYSE: NSM), Fairchild Semiconductor (NYSE: FCS), and International Rectifier (NYSE: IRF) enable smart power management and contribute to the reduction of fossil fuel consumption.

National Semiconductor, with a 14.1% market share, is the leading supplier of power-management products, while Fairchild Semiconductor generates more than 70% of its annual revenues from its power business. National’s PowerWise energy-conservation technology has helped create power-efficient systems that conserve energy and increase the battery life of portable devices. Fairchild’s Power Franchise, meanwhile, includes a portfolio of products that convert, control, and condition power to ensure maximum efficiency for a variety of consumer electronic goods, from cell phones to plasma screens.

International Rectifier’s iMOTION products reduce energy consumption in appliances that have traditionally not used such power-management technologies, such as washing machines, refrigerators, and air conditioners. Increased adoption of these technologies is estimated to potentially reclaim 10% of energy consumption worldwide. That would save 7 billion barrels of oil per year.

The probable impact: light-emitting diodes

According to the U.S. Department of Energy, general illumination is expected to undergo a major transformation in the next few decades from improvements in solid-state lighting. The 2005 Energy Policy Act, in fact, makes solid-state lighting technology a national priority.

Lifetime ownership costs of light-emitting diodes (LEDs) for general illumination are currently higher than for those of conventional lighting sources. But the combination of greater efficiency, longer durations, and falling LED prices offers the potential that LED lifetime ownership costs will eventually undercut conventional lighting costs. The U.S. Department of Energy estimates that by 2025, solid-state lighting has the potential to reduce national energy consumption for lighting by 29%, thereby deferring the need for 40 new thousand-megawatt power plants.

Cree (Nasdaq: CREE), as the leading U.S. manufacturer of LEDs, is at the center of this lighting revolution. Technological advances at Cree have helped the company demonstrate LEDs offering 100 lumens per watt, a strength that rivals commonly used fluorescent bulbs. By making LEDs more efficient, brighter, and cheaper, Cree seeks to contribute to energy conservation by driving the realm of LEDs from merely lighting cell phones and LCD screens to illuminating streets and parking lots.

The possible impact: leveraging IT

There is significant untapped potential in leveraging the power of information technology to reduce energy consumption. Most of this potential will be brought to fruition as the cost of energy escalates and the price of gathering and transmitting information declines.

New networking and wireless technologies are providing consumers with easy access to information about physical-world factors such as temperature, humidity, light level, and energy consumption. Such data can be used to better manage energy consumption in the industrial and commercial sectors.

Retailers such as Target (NYSE: TGT) and Best Buy (NYSE: BBY), for example, can collect information on temperature, lighting levels, and foot traffic and improve the energy efficiency of their stores accordingly while enhancing their patrons’ shopping experience.

Such ideas are not totally futuristic. The basic components of enhanced energy-management systems are already in place. The automated digital controls for a store’s HVAC, lighting, refrigeration, and electrical systems can be linked over the Internet to a single remote operating center that monitors the systems around the clock.

For example, the Metasys system, from facility management and control company Johnson Controls, integrates all of the building equipment in a facility and organizes the information in a logical manner. By working collaboratively with IT companies such as Cisco Systems, companies like Johnson Controls can enhance the capabilities of their systems.

Charging up with unappreciated plays

Technology companies tend to sport higher expected growth rates in earnings per share than do auto companies, and they tend to be more seasoned than alternative-energy players. And technology stocks, unlike their energy brethren, have not been part of a leading group in the equity market this year. As such, many tech stocks trade at a modest premium to the market price-to-earnings multiple while offering prospects for substantially higher EPS growth. And finally, having been overlooked during the energy rally, such technology stocks may not be as vulnerable as alternative-energy companies could be, should energy prices decline.

While tech stocks may not offer a pure play into energy conservation, some of them do stand to benefit in measurable ways should the energy-conservation theme gain momentum. Investors willing to scout for such companies and get in ahead of the crowd may well prosper. Those preferring to leave the task of security selection to an exchange-traded fund have an option, too. The PowerShares WilderHill Clean Energy Portfolio (AMEX: PBW), with about 30% of its assets in the technology sector, is ripe for the taking.

In short, investing in energy need not be limited to the sectors most of us instantly think of. If you do some digging, you might just find a wide range of investment options that offer great potential for your portfolio as well as for conservation.

Best Buy is a Motley Fool Stock Advisor recommendation.

Sam owned shares in Cree and International Rectifier at the time of publication. The Motley Fool has a disclosure policy.

Stodgy Stocks Can Grow Your Portfolio

This article originally appeared in The Motley Fool on December 2, 2004.

By explicitly considering the odds of a company growing faster than expected, investors can reduce the agony of watching share price and earnings-per-share trends diverge. Here are some mainstream ideas to get started in the right direction.

Buying and holding companies with growing earnings per share (EPS) is hailed as one of the recipes for success in the stock market. While there is some truism in this, there is more to the story. Sometimes the stodgy low-expectation stocks can be growth stocks after all.

Take, for example, companies like Amgen (Nasdaq: AMGN), Cisco Systems (Nasdaq: CSCO), Clear Channel Communications (NYSE: CCU), Coca-Cola (NYSE: KO), General Electric (NYSE: GE), and Home Depot (NYSE: HD).

These companies have increased their EPS substantially over the past few years. This year, Cisco and Clear Channel are expected to deliver EPS numbers up about 150% over their 2000 results. Yet, after adjusting for splits, shares of these companies trade at levels lower than they did several years ago.

The following chart illustrates exactly how EPS has increased for these companies.

CompanyStock PeakEPS in FY in Previous ColumnPeak PriceCurrent FY Est. EPSCurrent PriceEPS ChangePrice Change
 Fiscal Year$/Share$/Share$/Share$/Share  
Cisco20000.3682.000.9019.23Up 150%Down 77%
Clear Channel20000.5795.501.4234.76Up 149%Down 64%
Qualcomm20000.43100.001.0341.40Up 140%Down 59%
Coca Cola19981.4288.932.0039.86Up 41%Down 55%
Gen. Electric20001.2760.501.6135.44Up 27%Down 41%
Home Depot20011.1070.002.2643.37Up 105%Down 38%
Amgen20001.0580.432.4360.21Up 131%Down 25%
Data: Standard & Poor’s

What went wrong? While increasing EPS is good, what is more important is the comparison between expected and actual growth rate. These companies did not increase EPS at rates they were expected to some years ago. Overestimating business prospects is a common nemesis of growth stock investors. A perfect example is the dot-com era, when investors and corporations overestimated growth prospects.

The omnipotent growth rate

Irrespective of whether a stock is classified growth or value, it is the present value of the company’s future free cash flows that determines how much the underlying business is worth. Obviously, a projection of rapidly rising free cash flows significantly increases the value of the company, i.e., its stock price. Therefore, growth rate becomes a key driver in how much a business is worth.

Implicit in every stock price is an estimate of the company’s future growth rate. Finding companies where the actual growth rate will turn out to be higher than the forecasted or implied growth rate increases the odds of getting rewarded as an investor.

To take a stab at identifying companies likely to exceed the expected growth rate, the first step is to figure out the expected growth rate. Constructing a discounted cash flow model can come in handy since, assuming your projections are correct, the implied growth rate can be backed out. If the DCF minutia is daunting, you can use the long-term EPS growth rate, projected by analysts, as a surrogate.

Then comes the real work: assessing whether the company is actually likely to exceed the implied growth rate. Understanding the company’s drivers of sustainable growth — new products, proprietary technology, demographic changes, etc. — is a starting point. The more important part is to focus on how these drivers may change in the future and how such changes may impact the growth rate.

The P/E/growth, or PEG, ratio is often used to ensure growth is purchased at a reasonable price. Although this tool offers a short cut, it does come with baggage. The push toward selecting stocks with lower PEG ratios penalizes companies with low growth expectations — a fertile ground of underappreciated stocks. Likewise, higher quality companies that deserve a higher P/E multiple may also get cut out.

Seeking growth in value

Shares of companies with high expectations are more at risk for growth rates not panning out as high as expected. One way to reduce the risk of overpaying for growth is to snoop around for companies with low expectations.

While the approach is unlikely to yield a moon rocket, it can lead to some stodgy growth picks. “Stodgy growth” may seem like an oxymoron, but it’s through such a strange combination that the potential for unique profit is created. With the market having come around close to a full circle from the go-go growth days of the late ’90s, the task of finding such growth stocks has become easier.

For a start, take a look at Home Depot, Nextel Communications (Nasdaq: NXTL), Time Warner (NYSE: TWX), and McDonald’s (NYSE: MCD). Given that investors do not appear to be in love with these stocks, they sport modest, yet meaningful, growth rate projections with possibility for upside. In my mind, favorable resolution on factors bugging each of these stocks appears likely. And savvy value managers have loaded up on some of these stocks.

Company5-Year Estimated Growth RatePEG Ratio
Home Depot13.0%1.30
Nextel12.9%1.22
Time Warner12.1%2.30
McDonald's8.1%1.96
Data: Yahoo! Finance

In the battle between Lowe’s (NYSE: LOW) and Home Depot, investors have seemed fixated with Lowe’s as it continues to attack Home Depot’s store base. Meanwhile, Home Depot is executing quite well under the leadership of Bob Nardelli, with same-store sales ticking up nicely. Home Depot recently upped its 2004 EPS growth guidance from 14%-17% to 19%-20%. Analysts have followed suit and bumped up predicted EPS growth to a 20.2% clip this year. Their expectation for growth over the next five years remains a more modest 13.0% annually, which in turn leaves the company with the possibility of exceeding expectations.

Shares of Nextel, the top holding (as of 11/26/04) of Bill Miller’s Legg Mason Value Trust (FUND: LMVTX), have been tethered back due to concerns over the company cost-effectively swapping wireless spectrum licenses with safety agencies. A few months ago, Verizon Communications (NYSE: VZ) vehemently opposed Nextel’s spectrum swap plan, which was approved by the Federal Communications Commission in July. The gripe was that the spectrum Nextel was receiving was worth substantially more than the value estimated by the FCC. Earlier this month, though, Nextel and Verizon reached an amicable settlement. The next frontier for wireless carriers is data services. And, Nextel’s capital expenditure plans suggest that the company does not want to be left behind. The 12.9% 5-year growth rate expected by analysts for the nation’s largest pure-play wireless carrier may well prove to have been conservative.

Remember Time Warner? This company has come full circle after agreeing to merge with AOL, forming AOL-Time Warner, and then dropping AOL from its name. Time Warner investors have been less than amused with the lawsuits and investigations surrounding the company, not to mention the shrinking subscriber base of the AOL narrowband business.

Time Warner appears to be making headway on at least one of the major issues: The company is reported to be working out a $750 million settlement with the Securities and Exchange Commission. Time Warner is, however, a big free cash flow machine — close to $4 billion big. Whether the present management can hit some home runs with this cash to trounce the expected growth rate is the $64,000 question. Time Warner wins the Motley Fool Stock Advisor’s approval.

The stellar same-store numbers posted by the U.S. operations of McDonald’s have not whetted investors’ appetites. The Mad Cow disease scare, obesity issues, and management health have drawn attention instead. The recent appointment of James Skinner as CEO is likely to bring stability. The hamburger chain has the potential to exceed the analyst-expected 8.1% five-year growth rate if it can replicate its U.S. successes in Europe — and help “degrease” waistlines. Bill Nygren has found McDonald’s compelling enough to make it Oakmark Fund’s (FUND: OAKMX) second-largest holding as of September 30, 2004.

There are more stocks in today’s market than just Home Depot, Nextel, Time Warner, and McDonald’s. So, as part of your holiday shopping plans, seek bargains like you would for a value stock, while keeping an eye out for growth. If you do, you will likely find stocks with the prospects for above-average EPS growth trading with the attributes of their value brethren. In due course, they may prove to be a good deal.

What’s Driving Biotech

Biotechnology, which has been on a roll, declined after the much-anticipated American Society of Clinical Oncologists meeting in early June in New Orleans, where cancer specialists deliberated on the merits of new treatments.

The two extant ETFs which focus on this industry are iShares Nasdaq Biotechnology (AMEX:IBB) and Biotech HOLDRs (AMEX:BBH).

Before deciding to dump or load up on biotech ETFs, investors may find it worthwhile to look at the 3C’s driving this sector: Cancer, Cycle-time, and Consolidation.

Cancer

A hotbed of activity, cancer research has attracted lot of attention. The buzzwords are “targeted drugs”. Unlike traditional forms of cancer treatment which do not discriminate between healthy and malignant cells, targeted drugs act more like smart weapons. They take on the molecular mechanisms involved in the growth of cancer without hurting the surrounding healthy tissue, and offer the possibility of making the disease a manageable, chronic condition.

Tarceva, an experimental drug developed by OSI Pharmaceuticals (Nasdaq:OSIP) and licensed to Genentech (NYSE:DNA) and Roche (ROG.VX) is one of the more highly profiled targeted drugs. The drug shows promise in extending the lives of lung cancer patients when used in combination with Avastin, another cancer drug produced by Genentech. Tarceva’s efficacy against pancreatic cancer is being investigated in a Phase III trial and results are due in the second half of 2004.

ImClone’s (Nasdaq:IMCL) Erbitux, that is already approved for treating colon cancer, is another targeted drug that is in the limelight. According to data presented at the ASCO meeting, head and neck cancer patients treated with Erbitux and radiation had a median survival rate nearly twice as high as those who received radiation alone.

Cycle-time

Thanks to an efficient Food and Drug Administration, the time required for FDA review has shortened. With priority review having been granted by the FDA to Gilead Sciences’ (Nasdaq:GILD) Viread/Emtriva combination anti-HIV pill, a decision is now expected in September, four months earlier than the originally expected January 2005.

Compare performance of IBB and BBH ETFs.

Biotech ETFs, Biotech HOLDRs (BBH) and iShares Nasdaq Biotechnology (IBB), have performed quite differently in the past two years. BBH is up almost 70% compared to IBB’s 42% gain.

Companies for their part are also aggressive in reducing cycle-time. Genentech, for example, was ready to launch Avastin literally within hours of getting FDA approval. Helped by favorable test results, Elan (NYSE:ELN) and Biogen Idec (Nasdaq:BIIB) have filed for their multiple sclerosis drug, Antegren, a year earlier than expected.

Consolidation

The organic growth of biotechnology companies has proven to be a long and uncertain process. While biotechnology firms seek to merge among themselves, pharmaceutical companies are also targeting biotechnology companies.

Last year Biogen and Idec merged to form Biogen Idec. The Biogen-Idec merger was driven by the need to reduce risks, derive advantages of scale, and enhance domain expertise. This year, Amgen (Nadsaq:AMGN) has announced its intent to buy 79% of Tularik (Nasdaq:TLRK) it does not already own. Tularik shores up Amgen’s pipeline by bringing in five products in various stages of clinical testing with T67, the liver cancer drug, in Phase III trials. Recently, QLT (Nasdaq:QLTI) and Atrix (Nasdaq ATRX) have agreed to merge, moving closer to becoming a fully integrated biopharmaceutical company.

Major pharmaceutical firms, faced with the double whammy of weak drug development pipelines and upcoming patent expirations, are looking to purchase biotech firms in order to rev up their growth engines. Recently, Belgium-based UCB (UCBBt.BR) has offered to buy U.K.’s largest biotech firm, Celltech (NYSE:CLL).

The potential of targeted drugs, shortening of cycle-times, and possibilities of buyout provide a powerful case for investing in the biotechnology sector. So how does one play the biotech cycle?

Investing in biotech stocks has never been for the faint-hearted. News from clinical trials can make or break a company’s share price. One needs to only look at the ‘Slim-Jim’ type one-day moves to the upside and downside in OSI Pharmaceuticals and Genta (Nasdaq:GNTA), respectively, to get the picture.

This sector has been on a roll ever since Genentech vaulted 45% on May 19, 2003 following positive news from Phase III trials of Avastin in colorectal cancer patients. However, many biotech companies have high cash burn rates. Even the profitable ones have relatively few marketed products. For companies in this universe, the value is predicated on cash flows that are forecasted to come through several years out. As such, it makes sense to invest in a basket of biotech companies rather than one single entity.

The two ETFs that focus on the biotech industry, IBB and BBH, have subtle yet important, differences. From April 30, 2003 through June 16, 2004, the IBB has advanced 29% compared to the 39% gain for the BBH.

The iShares fund is designed to track the Nasdaq Biotechnology Index and includes over 100 biotech companies that trade on the Nasdaq. As of March 31, 2004, the top 10 holdings in IBB had a combined weighting of about 37%, with Amgen by itself having a 17% weighting. A notable absentee in IBB is Genentech, whose shares trade on the NYSE.

The Biotech HOLDRS, on the other hand, are Depositary Receipts that represent an undivided beneficial ownership in the common stock of 18 biotech companies. This ETF is concentrated: as of June 10, 2004, the top 5 industry heavyweights, Amgen, Genentech, Biogen Idec, Gilead Sciences, and Chiron (Nasdaq:CHIR), had a combined weighting of about 79%. One twist of BBH is that it has to be traded in round lots of 100 shares; one lot, at about $140 per share, takes a cool $14,000.

While bottoms are hard to pick, there is a case to be made for going long with this sector. Between the two available ETFs, the iShares fund offers better diversification and has higher exposure to development-stage companies. Some of the development-stage companies have appeal as takeover candidates, whereas the industry leaders in the HOLDRS fund are more likely to be buyers than sellers. IBB has lagged behind BBH, partly because of the lack of exposure to high-flying Genentech shares that trade at a 50 forward P/E. This could actually become an advantage for IBB if Genentech shares were to lag other firms.

This article originally appeared in ETFZone.com.

Playing the High-Stakes Biotech Game

Investing in biotech stocks has never been for the faint-hearted as many biotech companies have high cash burn rates. The biotech industry however has a few things going for it. Read on to learn more about investment opportunities in this industry.

Shares of biotechnology companies have declined, after the much anticipated American Society of Clinical Oncologists meeting in early June in New Orleans. This sector has been on a roll ever since Genentech (NYSE: DNA) vaulted 45% on May 19, 2003 following positive news from Phase III trials of Avastin in colorectal cancer patients. Is the recent correction a good time to fish or cut-bait?

Before you decide to dump or load up on biotech stocks, it is worthwhile to look at the 3C’s driving this sector: Cancer, Cycle-time, and Consolidation.

Cancer.

A hot-bed of activity, cancer research has attracted lot of attention. The buzzword is ‘targeted drugs’. Unlike traditional forms of cancer treatment which do not discriminate between healthy and malignant cells, targeted drugs act more like smart weapons. They take on the molecular mechanisms involved in the growth of cancer without hurting the surrounding healthy tissue, and offer the possibility of making the disease a manageable, chronic condition.

Tarceva, an experimental drug developed by OSI Pharmaceuticals (Nasdaq: OSIP) and licensed to Genentech and Roche (ROG.VX) is one of the more highly profiled targeted drugs. The drug shows promise in extending the lives of lung cancer patients when used in combination with Avastin. Tarceva’s efficacy against pancreatic cancer is being investigated in a Phase III trial and results are due in the second half of 2004.

ImClone’s (Nasdaq: IMCL) Erbitux, that is already approved for treating colon cancer, is another targeted drug that is in the limelight. According to data presented at the ASCO meeting, head and neck cancer patients treated with Erbitux and radiation had a median survival rate nearly twice as much as those who received radiation alone.

Cycle-time.

Thanks to an efficient Food and Drug Administration, the time required for FDA review has shortened. With priority review having been granted by the FDA to Gilead Sciences’ (Nasdaq: GILD) Viread/Emtriva combination anti-HIV pill, a decision is expected in September, four months earlier than the originally expected January 2005.

Companies for their part are also aggressive in reducing cycle-time. Genentech, for example, was ready to launch Avastin literally within hours of getting FDA approval. Helped by favorable test results, Elan (NYSE: ELN) and Biogen Idec (Nasdaq: BIIB) filed for their multiple sclerosis drug, Antegren, in May 2004, a year earlier than expected.

Consolidation.

The organic growth of biotechnology companies has proven to be a long and uncertain process. While biotechnology firms seek to merge between themselves, pharmaceutical companies are also targeting biotechnology companies.

Last year Biogen and Idec, merged to form Biogen Idec. The Biogen Idec merger was driven by the need to reduce risks, derive scale advantages, and enhance domain expertise. This year, Amgen (Nadsaq: AMGN) has announced its intent to buy 79% of Tularik (Nasdaq: TLRK) it does not already own. Tularik shores up Amgen’s pipeline by bringing in five products in various stages of clinical testing with T67, the liver cancer drug, in Phase III trials. Recently, QLT (Nasdaq: QLTI) and Atrix (Nasdaq: ATRX) have agreed to merge to move closer to becoming a fully integrated biopharmaceutical company.

Major pharmaceutical firms faced with the double whammy of weak drug development pipelines and upcoming patent expirations are looking to purchase biotech firms to rev up their growth engines. Recently, Belgium based UCB (UCBBt.BR) has offered to buy U.K.’s largest biotech firm, Celltech (NYSE: CLL).

The potential of targeted drugs, shortening of cycle-times, and possibilities of buyout provide a powerful case for investing in the biotechnology sector. So how does one play the biotech cycle?

Investing in biotech stocks has never been for the faint-hearted. News from clinical trials can make or break a company’s share price. One needs to only look at the ‘Slim-Jim’ type one-day moves in OSI Pharmaceuticals to the upside and Genta (Nasdaq: GNTA) to the downside, to get the picture.

Many biotech companies have high cash burn rates. Even the profitable ones have relatively few marketed products. For companies in this universe, the value is predicated on cash flows that are forecasted to come through several years out. As such, it makes sense to invest in a basket of biotech companies rather than one single entity.

Today’s marketplace offers several opportunities for investing in the biotechnology sector. First, there is Fidelity Select Biotechnology (Nasdaq: FBIOX), an actively managed, no load sector fund. With over $2 billion in assets, this is by far the largest open ended mutual fund that focuses on biotechnology. From April 30, 2003 through May 31, 2004, FBIOX has advanced 36.6%. As of March 31, 2004, FBIOX held 60 stocks with the top 10 holdings accounting for about 64% of the portfolio. Top holdings in this fund included names like Genentech, Biogen Idec, Gilead Sciences, Cephalon (Nasdaq: CEPH), and Millennium Pharmaceuticals (Nasdaq: MLNM). A noticeable absentee among the fund’s top 10 holdings was industry heavy weight, Amgen.

There are two exchange-traded funds (ETFs) that focus on the biotechnology industry as well: iShares Nasdaq Biotechnology (AMEX: IBB) and Biotech HOLDRs (AMEX: BBH). There are some subtle, yet important differences to consider between the two exchange-traded funds. From April 30, 2003 through May 31, 2004, the IBB has advanced only 31.9% compared to the 45.3% gain for the BBH.

The iShares are designed to track the Nasdaq Biotechnology Index and include over 100 biotech companies that trade on the Nasdaq. As of March 31, 2004, the top 10 holdings in the iShares had a combined weighting of about 36% with Amgen by itself having a 17% weighting. A notable absentee in the iShares is Genentech whose shares trade on the NYSE.

The Biotech HOLDRS, on the other hand, are Depositary Receipts that represent an undivided beneficial ownership in the common stock of 18 biotech companies. This ETF is concentrated; as of June 10, 2004, the top 5 industry heavyweights, Amgen, Genentech, Biogen Idec, Gilead Sciences, and Chiron (Nasdaq: CHIR) had a combined weighting of about 79%. One twist of the HOLDRs is that they have to be traded in round lots of 100 shares; one lot of the BBH at about $140 per share takes a cool $14,000.

In sum, while bottoms are hard to pick, there is a case to be made for being long this sector. Among the options available, Fidelity Select Biotechnology and iShares appear more attractive. For one, they offer better diversification. Further, exposure to development stage companies is higher. Some of the development stage companies have appeal as takeover candidates whereas the industry leaders in the HOLDRS are more likely to be buyers than sellers.

Fidelity No Load Mutual Funds: Supercharge Your Portfolio’s Returns

Investors who exclusively use broadly diversified, no load mutual funds for their stock investments often lose out on opportunities to increase the reward potential of their portfolios. This article looks at two methods investors may use to enhance the performance of their portfolio of diversifed, no load mutual funds.

Diversify, diversify, diversify!
Rebalance your portfolio periodically.

These have become the mantra in the post dot-com era. Stocks, bonds, and cash typically form the major asset classes for constructing portfolios of no load mutual funds. Lot of emphasis rightly gets placed on the percentage of assets allocated to no load mutual funds of different asset classes. However, the division of assets within a particular class does not nearly get the attention it should.

All too often, investors exclusively use broadly diversified, no load mutual funds for their stock investments. Fidelity Magellan Fund (Nasdaq: FMAGX) and Fidelity Contrafund Fund (Nasdaq: FCNTX) are examples of popular Fidelity funds investors commonly use. By following this approach, investors often miss out on opportunities to enhance the reward potential of their portfolios.

In a related article, we have looked at how investors can use sector funds to construct a diversified, no load mutual fund portfolio. In this article, we look at how investors can use sector funds to enhance the performance of their portfolio of diversified, no load mutual funds. Although Fidelity funds are presented as examples, the concepts outlined here can be implemented using sector funds managed by other institutions such as Vanguard or T. Rowe Price.

Sector funds confine their investments to a particular sector of the economy. Fidelity funds managed under the Select Portfolios® are sector funds. For example, Fidelity Select Energy (Nasdaq: FSENX) is a no load mutual fund that focuses its investments on various segments of the energy industry such as integrated oil companies, oil and gas exploration and production companies, and oil field service companies.

So how does one use sector funds to increase the performance potential of a portfolio of diversified, no load mutual funds?

Focus on sectors with growth opportunities

An investor having a portfolio of diversified, no load mutual funds may commit a portion of her assets to sector funds that focus on areas having significant growth opportunities, e.g., electronics or software. Some financial professionals call this the ‘core and satellite’ portfolio approach where the diversified, no load mutual fund is the core and the sector fund is the satellite holding. Investments in Fidelity funds like Fidelity Select Electronics (Nasdaq: FSELX) or Fidelity Select Software and Computer Services (Nasdaq: FSCSX) can enable the investor add emphasis on growth sectors such as electronics and software, respectively.

Take a proactive approach to sector investing through sector rotation

Like in the previous case, an investor having a portfolio of diversified, no load mutual funds commits a portion of her assets to sector funds. With this approach, the investor however seeks to maximize the potential of the portion of assets committed to sector funds by periodically switching assets into sectors with higher expected returns.

For example, until not too long ago, major corporations pruned technology related capital spending whereas falling interest rates kept consumer spending strong. To profit from such secular trends, an investor may choose to invest in Fidelity funds such as Select Consumer Industries (Nasdaq: FSCPX) and Select Leisure (Nasdaq: FDLSX) while avoiding Select Technology (Nasdaq: FSPTX).

AlphaProfit.com’s research indicates that sector rotation has the potential to outperform the market averages on the basis of relative returns as well as risk-adjusted returns. To employ this approach effectively, you need to understand and follow the dynamics of the individual sectors. You must also be able to make informed decisions on sectors to select and sectors to avoid.

The Impact on Your Portfolio

Strong performance from a portion of assets committed to sector funds can materially enhance the return of your portfolio of no load mutual funds. Fidelity funds such as Select Electronics and Select Software and Computer Services sport 10 year average annual returns of close to 18%; this is nearly twice the 10 year average annual return of 9.4% for the Fidelity Magellan Fund. Using tactical, infrequent rotation of assets among sectors, the AlphaProfit’s Focus™ model portfolio has increased at an average annual rate of 34.4% since 1993.

So what do these return rates translate to you in dollar terms? A $100,000 investment in a diversified, no load mutual fund that grows at 10% per year results in $259,374 at the end of 10 years. If the same $100,000 is divided such that $85,000 is invested in the same diversified, no load mutual fund growing at 10% per year and the remaining $15,000 is invested in sector funds growing at 30% per year, the assets will total $427,256 at the end of 10 years. That is $167,882 or 65% more than the $259,374 resulting in the former case.

Thus by allocating even a relatively small, say 15%, of the total portfolio of no load mutual funds to sector funds, you can dramatically increase your returns.

Key Points to Remember

1. Investors who exclusively use broadly diversified, no load mutual funds for their stock investments often miss out on opportunities to enhance the return of their portfolios.
2. Sector funds can serve as a valuable return enhancing booster for an investor owning a portfolio of diversified, no load mutual funds.
3. Investors may choose to take a passive long-term approach to investing in sector funds that target high growth sectors of the economy. Alternatively, an investor can take a proactive approach to maximize the potential of sector funds by periodically switching assets into sectors with higher expected returns.
4. Investors willing to look beyond broadly diversified, no load mutual funds have a powerful ally in sector funds. Such investors can materially increase portfolio returns by committing a relatively small fraction of their total assets invested in diversified, no load mutual funds to sector funds.

Biotech Funds FBIOX

The favorable dynamics for the Biotechnology industry is attracting investor attention. On the heels of recent gains, there are reasons to be optimistic on continued out-performance.

An efficient Food and Drug Administration, progress on extension of new products, trouble in ‘major pharma’ land and reasonable valuation create a favorable milieu for investing in the biotechnology sector. These conditions have not gone unnoticed by investors on Wall Street. Since the beginning of 2004, the Fidelity Select® Biotechnology Fund (FBIOX), that concentrates its investments in this sector, is up 9.9% compared to 2.6% for the broader Wilshire 5000® Total Market Index. Investors have also warmed up to biotech IPOs helping companies like Dynavax Technologies (NDQ: DVAX), Renovis (NDQ: RNVS), and Corgentech (NDQ: CGTK) get out of the gate.

The Food and Drug administration has gotten its act together.

Approval times for new drugs have been significantly reduced. Last year Millennium Pharmaceuticals (NDQ: MLNM) got FDA approval for its treatment of multiple myeloma, a form of blood cancer, in four months after filing the application. This year, approval for Genentech’s (NDQ: DNA) cancer formulary, Avastin, came earlier than expected. Well-managed companies like DNA have also shortened the lead time to market from their end. The company launched the drug literally within hours of getting approval for Avastin. Elan (NYSE: ELN ) and Biogen Idec (NDQ: BIIB) are working to expedite the approval for their multiple sclerosis drug, Antegren, about a year earlier than expected.

Growth from new products.

he quest for new applications of existing therapies is vigorous. DNA is targeting to become a power house in oncology. Building on the success of Avastin against colorectal cancer, the company is targeting the drug’s application towards other forms of cancer including kidney, pancreas,and lung.

 

“The quest for new applications of existing therapies is vigorous. Increasing the weighting of an investment portfolio towards this aggressive industry group of the healthcare sector may prove timely for venturesome investors.”

Avastin works by inhibiting blood vessel formation. The company is also working on 5 new cancer drugs. Such efforts should help DNA achieve its goal of growing EPS at over a 20% clip for several years beyond 2005. Likewise, MLNM is seeking to derive higher revenues from its cancer product, Velcade. Seeking to extend the application of Velcade beyond multiple myeloma to several other types of cancer, the company will have about 80 different trials by the end of 2004. MLNM is also working with European regulators for the approval of Velcade across the pond.

Given its dominant position in the industry, no analysis of the biotechnology industry group is complete without looking at Amgen (NDQ: AMGN). The Thousand Oaks, CA based sector flagship recently received FDA approval for Sensipar that is used to treat hyperparathyroidism stemming from chronic kidney disease. AMGN is working on increasing the target patient population for Sensipar from 300,000 to 1 million by showing the drug’s utility as a pre-dialysis therapy. With no significant competing drugs in this space, revenues from this drug could add up to be significant for AMGN. The company is also working to expand the usage for Enbrel that is currently used to treat various inflammatory diseases.

While the impact of the successes of research on future sales of biotechnology drug companies is obvious, such efforts also place more demands on biological agents and research tools. The latter along with the need to combat the threat of bioterrorism provides opportunities for companies like Invitrogen (NDQ: IVGN). IVGN acquired BioReliance earlier this year to improve its ribonucleic acid interference research. This acquisition will likely add about $130 million to IVGN’s annual revenues to push IVGN’s annual revenues beyond the $1 billion mark.

The travails of ‘major pharma’.

Upcoming patent expirations, that make room for low-cost generic substitutes, embattle the drug pipelines of major pharmaceutical companies like of GlaxoSmithKline (NYSE: GSK). One area major pharma companies are increasingly looking to shape up their fitness, is biotechnology. Development stage biotechnology companies with strong domain expertise are likely beneficiaries as major pharma companies seek collaborative drug development efforts and provide the financial and marketing muscle. GSK for example has collaborative programs with Exelixis (NDQ: EXEL) and Vertex Pharmaceuticals (NDQ: VRTX). GSK also has three compounds derived from Human Genome Sciences’ (NDQ: HGSI) database that are in clinical trials.

Valuation.

With the growth and excitement of new products and applications, the biotechnology industry group has seldom been fertile ground for the traditional value investor. Here is a quick look at the financial metrics of AMGN and DNA.

Metric AMGN    DNA
Price$58.45$108.33
Forward P/E  20.7    52.6
Price/Book    3.9      8.5
Ent. value/EBITDA  21.1    49.7
Source: Yahoo! Finance.

The prospects for sales and earnings growth for both AMGN and DNA are in excess of 20% with DNA’s prospects perhaps being higher. AMGN’s operating margins are a robust 50% in comparison to DNA’s 32%. Wall Street has been enamored with DNA’s news flow and bid up the company’s shares higher. By the same token, investors have been concerned with Medicare reimbursement rates for AMGN’s anemia treatment, Epogen. Wall Street has viewed AMGN more as a pharmaceutical company and has not given much credit for its deep drug development pipeline that includes potential $1 billion opportunities in formulations for osteoporosis (AMG162) and mouth sores (Paliferrin). Recently, AMGN also acquired the 80% of Tularik (NDQ: TLRK) it does not own. This acquisition gives AMGN development programs in cancer, auto-immune diseases and metabolic diseases. To us, AMGN appears attractively priced from a historical perspective on most metrics.

Although biotechnology companies in the aggregate need more years to get to profitability, the winds for investing in the biotechnology sector appear favorable. The optimism however needs to be balanced with the virtual certainty that some of the research and development efforts in this industry will fail to deliver on promises. All said, increasing the weighting of an investment portfolio towards this aggressive industry group of the healthcare sector may prove timely for venturesome investors.