Inside the Madness

Cramer: How to Track Down Speculative Winners

From: Nicole Urken
Sent: Monday, November 21, 2011 7:30 AM
To: James Cramer
Subject: And our big run comes to an end!! VRUS!!

Pharmasset to be acquired by GILD for $137 in cash

From: James Cramer
Sent: Monday, November 21, 2011 7:31 AM
To: Nicole Urken
Subject: RE: And our big run comes to an end!! VRUS!!

HOLY COW—please send me our recommendation!!

From: Nicole Urken
Sent: Monday, November 21, 2011 7:35 AM
To: James Cramer
Subject: And our big run comes to an end!! VRUS!!

Just fwded you our orig memo. We recommended VRUS just over a year ago on 10/12/10 during our “Drug Hope” series at split-adjusted $15.87, which represents a 763% gain on the take-out price.

A 700 percent one-year gain in a recommendation? This kind of return reminds us that, well, sometimes it is better to be lucky than good—a highly referenced Cramer phrase. However, it also highlights the important role of speculation as part of broader investment strategy. As Jim often discusses, many investment professionals advise against speculation as too risky or worse: irresponsible.  However, with gains like the one locked in at Pharmasset , we are reminded that speculation helps keeps you in the game, particularly amidst a volatile and uncertain macro environment.  After all, speculation isn’t a guessing game or gambling bet. The expression that “luck is the by-product of hard work” fits here as well—because doing the research for well-positioned names and managing your risk appropriately can provide the opportunity of large rewards.

While Europe’s sovereign debt woes and the supercommittee’s shortcomings dominate headlines, if you were a "Mad Money" viewer who bought Pharmasset last October, you locked in a big gain. And that is why doing the work matters.

So, how did we isolate Pharmasset and who could be next?

Last October, we ran a “drug hope” series to look at companies who are investing in cures for diseases that are, unfortunately, growing problems.

How did we choose Hep C to be one of our highlighted categories? Importantly, Hep C, which spreads from blood-to-blood contact and can eventually destroy your liver, had recently been getting much attention from big pharma—a sector thirsty for growth. After all, Bristol Myers had just acquired Zymogenetics for its Hep C potential. Plus, from our research, we knew Hep C was a disease that affected a large population—170mm people worldwide—with limited treatment options that came with severe side effects. Pharmasset in particular stood out because their oral offering would eliminate the need for an injection, a component of the current treatment. And the growth opportunity is the very reason that Gilead—starved for growth—was willing to make an $11bn bet on the company on Monday—an 89 percent premium even after the huge run in the stock in the last year.

So, who else is well positioned here? Of course, another category of disease that is growing and in need of treatment is diabetes, which is projected to affect 25 percent of the U.S. population by 2024. Alkermes is well positioned here, despite its wild trading action over the last year. Its technology—which improves existing drugs by making it less burdensome for patients to take them—holds much potential, particularly for a disease like diabetes. This one’s diabetes treatment Bydureon—an improved version of Byetta—remains well positioned even after the recent fall out between its partners—Eli Lilly and Amylin—has created some uncertainty. Additionally, ALKS has upside from other offerings like Vivitrol, its treatment for opioid addiction and will benefit from its acquisition of Elan Drug Technologies, which we highlighted back in August on "Mad Money."

What else do we think is a key growth area in biotech? Cancer treatments. One of the best-positioned names is Celgene , which we recommended last week on "Mad Money," particularly ahead of the American Society of Hematology (ASH) conference in the beginning of December. And, if you want to focus on the diagnostic side, a well-positioned name is Exact Sciences, though this is a longer-term story.

Something else to keep in mind when looking for well positioned names in biotech?  Names with pricing power. When it comes to pricing, no category is better positioned than the orphan drug names. Some opportunities? Biomarin and Alexion , both names we have continued to be behind on "Mad Money." Orphan drugs treat diseases that affect tiny groups of patients, often rare genetic disorders that afflict as few as a couple of thousand people in the whole country. In order to encourage companies to develop these treatments, the U.S. government, along with the EU, provides enormous benefits for orphan drug developers—tax incentives, enhanced patent protected and marketing rights, along with some straight-up subsidies for clinical research. Genzyme (which was acquired by Sanofi-Aventis) was so attractive largely because of its orphan drug potential. While both BMRN and ALXN have had strong runs, they remain well-positioned at these levels—particularly as they are price insensitive.

What is key is risk management, which means (1) limiting your exposure—i.e. don’t have more than 10 percent of your portfolio in a speculative stock and (2) assessing your risk profile—After all, capital preservation is key particularly if you are using the money, say, to pay for college or to fund your retirement. But in a discretionary portfolio, if you do your research and put some of your money into a name that can reap outsized rewards, that’s something that could keep you in the game. Importantly, the big gainers are not penny stocks that no one has heard of.  While much market literature may suggest otherwise, the big names are not in the microcap names where the risk-reward trade off is often unfavorable.

The bottom line: Speculation is in. Just make sure to manage your risk, lock in some profits on the way up, and to do your homework. It pays off. And good homework, after all, paves the way for some luck.

"Inside the Madness" appears twice a week at

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