The healthcare stocks have been one of the hottest performing sectors for many years. Old name big cap stocks like J&J and Pfizer provide strong dividend yields and tremendous safety but that usually does not add up to outsized returns.

For the last decade or two, biotech has been the go to sector. Names like Medivation (MDVN) returned over 11,000%, Questcor (QCOR) 5000% or even Illumina (ILMN) returning just 4000% provided lots of joy to investors.

If you are tempted to dabble here are a few things to consider. Ideally, you should turn this into a part time hobby spending hours every week reading and doing research. Once you have found your target companies, be ready for long commitment and lots of volatility along the way.

Finally consider this rule of thumb. Private companies seeking venture capital funding are considered to have at most a 5% chance of success. Today development stage companies are seeking public capital well before most venture capitalists even consider them. This means the odds of success could fall well below 5%.

Where Is The Next Medivation

It doesn’t matter if you are a budding bioscientist or a smart investor; every one wants to be the next big Medivation. Investment bankers have having a banner year. I went through the list of healthcare IPO’s and SPO’s so far this year. Total filings have been running about 60 per month. Healthcare of all types has accounted for over 20% of the filings. That works out to almost 100 so far this year. I did not realize there was that many unsolved diseases in the world. How can they all be successful? How can you even know where to find the next Medivation?

Having sorted through months of filings and read endless S-1 documents, I am more than a bit skeptical. We have included a few examples in an effort to guide you in what to look out for.

Take Sienna Biopharmaceuticals Inc. who filed a $65 million IPO in late July. Here is how the company describes itself: “We are a clinical-stage biopharmaceutical company focused on bringing innovations in biotechnology to the discovery, development and commercialization of first-in-class, targeted, topical products in medical dermatology and aesthetics.

Translation: We have a few ideas about a skin cream. We have mixed up a batch in the lab but don’t have anything yet.

Consider Genprex who filed a $22.5 million IPO in late July. Here is their self-portrait: We are a clinical stage gene therapy company developing a new approach to treating cancer. We have a novel proprietary technology platform designed to administer cancer-fighting genes by encapsulating them into nanoscale hollow spheres called nanovesicles.

Translation: Even though billions have been thrown away in a vain attempt to cure cancer, we have discovered the path to a cure using little dots.

And then there is Aileron Therapeutics Inc. (ALRN). They define themselves as a clinical-stage biopharmaceutical company focused on developing and commercializing a novel class of therapeutics called stapled peptides. Their lead product candidate, ALRN-6924, targets the tumor suppressor p53 for the treatment of a wide variety of cancers.

Translation: ALRN-6924 is in multiple Phase 1 trials and this means it will be years before the first dollar of revenue comes through, if ever. And there is always the probability to consider that ALRN-6924 never makes it out of Phase 1.

Healthy Skepticism Is Needed

If these opinions seem overly critical, no apologies offered. In a market brimming with ever-higher valuations, lots of companies get foisted onto the public that possess little more than hope and vision. It is a sellers market for businesses that in other times would be advised to stay private and grow up using venture capital.

To be successful investing in healthcare, diversification is mandatory. Between 10-20 stocks will diversify and big cap portfolio. With early stage companies the number should be much more. In order to find the winners, you also have to be prepared to loose.

The next time flashy headline offers a top 10 list of hot performing healthcare stocks like Medivation, Questcor and Illumina remember to average these extraordinary stocks with the many others in you healthcare portfolio that never made a dime.