Reprinted with permission from World Finance Net IPO Newsletter, written by Alexander Frauenfeld

Investors who still need to look up Genomics in a dictionary should watch out, since the stock market's currently hottest industry could really burn them. Genomics, the study of gene structure and function in order to develop drugs, is the latest concept attracting investors and their money by the millions.

Flush with money from Internet stocks, investors have driven shares of genomics companies to new heights this year, on hopes health care will be revolutionized by what they do. What genomics companies do is map, analyze and sell data about the human genome, the highly complex set of molecules that forms the blueprint for life. Some of the companies are also using their genomic discoveries to develop new drugs. Spawned more than 10 years ago by government researchers, genomics seeks to understand how genes cause disease. That information could, these companies hope, change medicine from a science of treating symptoms to one of preventing disease altogether.

But for investors, who cannot tell a nucleotide from a peptide, the genomics industry is a tricky niche within the biotechnology field. At this point, it looks like a lot of money is pouring into a group of companies when few of the investors really know what those companies actually do.

Genomics has helped drive the current surge in biotechnology stocks, which has had regular jumps of 5% or better, and have notched the best gains of any NASDAQ sector so far this year. Some mutual fund managers have recorded gains of close to 80% with their Genomics-heavy Biotech funds. Companies such as Human Genome Sciences (HGSI), Millennium Pharmaceuticals (MLNM) and Celera Genomics (CRA) (click here for a WFN research report on MLNM or here for short profiles of the other two) have seen their stock prices increase exponentially the last couple of month if not weeks or sessions.

One rationalization for these developments is that baby boomers have made their money in the Internet and now they are looking to live forever and are turning to Genomics to realize those expectations. Among those expectations, investors expect Genomics companies to make drugs that work better with fewer side effects and to shorten drug development time, a process that now can take close to a decade and cost hundreds of millions of dollars. Some of those hopes already fell short in 1991-92 and in 1996, the last times biotechnology stocks turned hot and shortly afterwards disappointed investors.

So, why is this time around different? On the positive side, the current rally involves a leaner, smarter biotech industry. Firms have consolidated and expanded the number of drug trials, giving them more chances to make successful drugs. This strategy has attracted big fund managers who normally turn away from small companies in favor of large pharmaceuticals due to liquidity and other risks.

And, as it looks now, genomics could really deliver big. Already, researchers at Celera Genomics, which is a division of PE Corporation (PEB), announced they believe they have sequenced about 97% of human genes. The company expects to complete the missing 3% or so by the end of this year. Once the human genome is sequenced completely, the issues become translating the findings into drugs at an accelerated pace, and integrating the distinct data sources and tools.

As a result, investors should be very skeptical of Genomics companies whose sole business is selling gene data to other drug makers. While winning fees, which can be tremendous, for those sales, these companies give up valuable information that could lead to profitable drugs they could sell themselves. It would be better if they diversified by retaining some of their knowledge about genes and gene function in order to develop their own drugs.

Other areas of promise could be companies that make software to allow different gene databases to be used together.

One unknown is how successfully companies will patent human genes and the proteins they produce. It remains uncertain how the nations courts will define what constitutes a "genetic patent" because the field is so new.

For all that uncertainty, the high-priced genomics stocks, a few of which have jumped from single digits to well-over $200 a share, could be seen as overpriced. Not to misunderstand, genomics should be absolutely fundamental to the future of health care, but the actual payoffs are still a number of years away. People are just bidding these stocks up on pure future hope and anticipation. But be aware that at these valuations, it is a high-risk endeavor with a still uncertain future. Looking around for some gems in the rough could turn out to be more interesting.

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