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A survey of investable Canadian sectors will eventually lead back to biotechnology, a corner of the market sure to elicit some well-deserved skepticism.

With U.S. biotech stocks setting a torrid pace over the last several years, some of the hype was bound to spread to Canada, which has seen a recent uptick in biotech listings.

"Some Canadian companies will deservedly capture the attention of those investors and see astronomical returns," said Brian Bloom, president of Bloom Burton, a Toronto investment banking firm specializing in health-care companies. "But don't assume this tide will lift all Canadian boats, like it did in 2000, when any piece of crap could be floated and could triple."

Great potential gains will appeal to Canadian investors at a time when few other sectors do, but in a space rife with risk, neophytes should tread carefully.

Many in Canada learned that lesson a decade ago. Coincident with the tech boom, investors flocked to new biotech issues with the same fervour that inflated the tech-stock bubble.

A rash of companies went public around flimsy science and little chance of commercial success, said Tony Pullen, an investment banker with D&D Securities in Toronto and a Canadian biotech veteran. "The institutions that waded into the space did it so mindlessly, and when it rolled over, the bust kind of killed the sector at the institutional level."

The biotech sector, unlike pharmaceuticals, is made up of development-stage companies trying to bring a new drug or medical technology to market. Pharmaceutical companies tend to focus on making and marketing drugs that have already been approved.

What makes biotech investments so risky and so potentially lucrative is that their success or failure is a "binary" concern, Mr. Bloom said.

"They either work or they don't. They're heroes or zeroes," he said. These stocks can convulse around landmark events like clinical results or regulator decisions, which can move shares up by 300 per cent or down by 80 per cent in a single day. That makes biotech stocks poor candidates for buy-and-hold strategies and better suited to active trading.

For the same reason, biotech investing warrants a "basket approach" to mitigate risk, Mr. Pullen said. The pool of Canadian candidates, however, began to shrink after the tech bubble burst, which sparked a slow unwinding of lesser-quality biotech companies. The financial crisis in 2008-09 accelerated the process.

"That was the last thing the sector needed" after a series of clinical failures, Mr. Pullen said. "The biotech analysts dwindled down to a handful."

The success of Valeant Pharmaceuticals International Inc. and Paladin Labs Inc. renewed Canadian attention on pharmaceutical names, if not biotech.

The top five performing small-cap stocks of 2014 on the Toronto Stock Exchange with a market capitalization of at least $150-million included two pharmaceutical names: Concordia Healthcare Corp., and Cipher Pharmaceuticals Inc.

In the United States, the S&P 500 biotech index has tripled over the last three years, outpacing the broader stock index by a wide margin.

With Canadian resource stocks mostly proving a drag on returns over the last few years, the U.S. biotech boom raises the question of whether Canadians should also seek riches in domestic biotech. "Only when there seems to be a following from American investors," Mr. Bloom said.

"Of all the different things to investigate in a company – its science, its patents – the generalist investor has no skill to assess. What they can assess is who the other investors are, who the board members are and [whether] the managers have done this before."

One of his top picks is Trillium Therapeutics Inc., which recently raised money from some of the best U.S. health-care investors, Mr. Bloom said. The company is nearing the clinical trial phase in an area of cancer research called immuno-oncology. On the pharmaceutical side, the firm has "buy" ratings on Knight Therapeutics Inc. and Tribute Pharmaceuticals Canada Inc.

Jason Donville, president of Donville Kent, prefers the pharma side of health-care stocks, particularly Concordia, Cipher and BioSyent Inc. Those names offer solid potential returns without the inordinate risk associated with biotech, he said. "It's too hard to pick winners in that area."

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