I haven't ever heard him say it directly, but it's pretty clear that Warren Buffett has no interest in buying biotech companies. I don't know of any small drug company that Berkshire Hathaway  has ever invested in.

It's not that he avoids the health-care industry altogether. Berkshire owns shares of big pharmas: Johnson & Johnson , Sanofi, and GlaxoSmithKline . And it owns shares of DaVita, which runs dialysis centers.

But despite the potential monster returns, the Oracle of Omaha has avoided buying smaller biotechs. Here are a few quotes that might explain why.


"Never invest in a business you can't understand."
Buffett has admitted to not following the pipelines of the pharmaceutical companies he owns. That's OK for larger companies, where the growth of the drugs currently on the market has a large influence on the valuation. One pipeline success or failure isn't going to make or break Johnson & Johnson, with $67 billion in annual revenue, or Glaxo, with $40 billion. Adding a $1 billion blockbuster will increase revenue by less than 5%. Smaller drugs affect the top and bottom lines by even less.

Biotechs, on the other hand, live and die by their pipeline. Whether it's their first, second, or even third drug, the additional revenue is huge. If you're going to invest in biotechs, it's critical to understand the drugs in the pipeline, where they're at, their likelihood of success, potential sales, competition from other drugs on the market and in other companies' pipelines -- and the list goes on.

If Buffett doesn't want to put in the time to understand the nuances of the sector, I think he's right to stay away.

"Our favorite holding period is forever."
Even if Buffett wanted to put in the effort to learn the science -- and he's a smart guy, so I'm sure he could figure it out -- this Buffettism would make it difficult for him to make a purchase. A vast majority of biotechs swing from way undervalued to way overvalued, often over a very short time frame -- think months -- certainly not forever.

And there's a big difference between a development-stage biotech and a commercial-stage biotech; A company that might be great at developing drugs isn't necessarily one that can sell them well. Dendreon is a perfect example. Many investors thought its prostate cancer treatment Provenge wouldn't work. The FDA rejected it, asking for more data. The second trial proved that Provenge extended patients' lives, and shares shot up from under $3 to over $50 on FDA approval. Now, three years later, the company sits under $5, paralyzed by sales that didn't live up to expectations.

Unlike Coca-Cola or Heinz -- two Buffett-owned companies -- it can be hard to predict patient adoption and physician prescription numbers especially years before the drug is on the market.

The best way to profit in biotechs is to jump in when investors are ignoring the stock and jump out when they've overreacted. That's value investing, but it's not Buffett's idea of investing.

"We have got an elephant gun, and it's loaded."
Biotechs are far from elephants. Think squirrel or opossum.

A typical clinical-stage drugmaker is valued under $1 billion. Berkshire Hathaway invested $26 billion in Burlington Northern plus $10 billion in debt for the remaining part of the $44 billion company he didn't already own. Buffett invested about $13 billion in cash to get a large chunk of Heinz.

It takes a lot to move the needle at Berkshire. A little biotech isn't going to do it.

Ignore Buffett?
I hope they don't take away my jester cap for saying this, but I think it's OK not to follow Buffett. Biotech is clearly not for him, but I've never actually heard him say it's a bad idea for me and you.

In fact, all three reasons I've cited for why Buffett wouldn't want to buy biotechs are easily overcome by most investors: Learn about the industry, be willing to sell when companies become overvalued or the thesis changes, and don't become a billionaire.

And while I disagree with Buffett's possible reasons for not liking biotech, it's hard to argue with his thoughts about "the tapeworm that's eating at American competitiveness." Find out what Buffett was referring to in our free report: "What's Really Eating at America's Competitiveness." You'll also discover an idea to profit as companies work to eradicate this efficiency-sucking tapeworm. Just click here for free, immediate access.

The article 3 Reasons Buffett Hates Biotech originally appeared on Fool.com.

Fool contributor Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway, Coca-Cola, H.J. Heinz, and Johnson & Johnson and owns shares of Berkshire Hathaway, Dendreon, and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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