Forget Biotech's Binary Bets: This Dividend Stock Collects Royalties on Blockbusters Instead

Biotech companies are high-risk, high-reward investments. Usually, a biotech has just one drug in development, and if it gets that drug to market, you win. If the drug doesn't work out, you lose. You don't have to make binary bets like that if you buy Royalty Pharma (NASDAQ: RPRX). Not only does it have a professional management team that tracks drug developments, but it also invests in a diversified portfolio of drugs. Here's what you need to know before you jump aboard.

Royalty Pharma does things differently

The first thing to understand about Royalty Pharma is that it is neither a pharmaceutical nor a biotech company. It provides capital to drug makers and developers so they can advance their research. In exchange for the cash it provides, Royalty Pharma receives a royalty on sales generated by the drugs in which it invests. The royalties are usually modest relative to a drug company's profits, but Royalty Pharma has investments in many drugs, so the small royalties add up. Notably, the royalties require little to no expense for Royalty Pharma other than the upfront cash payment.

The reliability of Royalty Pharma's model is evident in the dividend, which has increased each year since the company went public in 2020. To be fair, this isn't a high-yield investment, offering a yield of just 1.5% as of this writing. The average pharmaceutical stock, for reference, yields around 1.4%. The real story here is the diversification Royalty Pharma offers in an industry that is often hit-or-miss.

A portfolio approach monitored by experts

The pharmaceutical and biotech sectors are highly complex and highly competitive. Attempting to cherry-pick winners is a tall task for the average investor, who likely isn't a specialist. Royalty Pharma is filled with specialists, all of whom are looking to find good investment candidates. And they have a pretty good track record of success, with 14 drugs that have outperformed original sales expectations. Half of those drugs have produced, or are expected to produce, sales that are more than twice what they were when Royalty Pharma made its original investment.

The ability to identify strong drug candidates clearly demonstrates the management team's capabilities. But the bigger story is that there are 14 drugs on that list. Not one or two. In fact, the company has investments in 35 approved products and 16 drugs still in development. It collects royalties on 16 drugs that generate sales of $1 billion or more, making them blockbusters.

Moreover, the drugs on which Royalty Pharma collects royalties are spread across different drug makers. So you aren't betting on the success of just one healthcare business; you're gaining exposure to multiple companies at once. When you buy Royalty Pharma, you are getting a diversified portfolio of both approved and developed drugs from across the pharmaceutical spectrum. One investment provides you with expansive exposure to the broader drug sector.

Royalty Pharma isn't perfect, but it is very good

The above-noted royalty success stories are impressive, but no company hits home runs with every investment it makes. Royalty Pharma makes mistakes, too. However, that actually highlights the benefit of the business model. Royalty Pharma's industry expertise and diversification have created a portfolio that has produced impressive results overall. It allows you to invest in the drug sector without taking on the often binary risk of buying a company with only one drug in development.

For most investors, Royalty Pharma will be a fairly low-risk way to add pharmaceutical exposure to a portfolio. But the best part is that the company is always looking for new drugs to invest in, so the portfolio will develop along with the drug sector. In other words, Royalty Pharma is likely to be a good buy-and-hold investment in a sector known for research-driven change.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.