Is Buying Royalty Pharma Stock a Safer Way to Bet on Revolution Medicines?

Revolution Medicines (NASDAQ: RVMD) just got some very good news: The FDA gave the company's RASONQUE breakthrough therapy designation. That could help speed the metastatic pancreatic cancer drug to market. But the stock is up 330% over the past year, so investors are already pricing in a lot of good news. Investors can still get exposure to Revolution Medicines if they buy Royalty Pharma (NASDAQ: RPRX), while also spreading their risk across a more diversified basket of pharmaceutical products offered by various drug makers. Here's why you may want to do just that.

What does Revolution Medicines do?

Revolution Medicines describes itself as "a global, commercial-stage oncology company dedicated to discovering, developing and delivering innovative medicines for patients with RAS-addicted cancers." That's a lot if you aren't a healthcare specialist, but the big takeaway is that the company makes drugs to treat cancer. Oncology is a very big field, so Revolution Medicines has many opportunities to develop new therapies.

Image source: Getty Images.

The FDA news regarding RASONQUE is clearly positive, indicating the company is seeing success in its drug development process. However, it is still just one company working in one pharmaceutical niche.

What does Royalty Pharma do?

Royalty Pharma buys royalties on drugs. It provides drug makers with cash up front so they can develop drugs. In exchange, it collects a piece of a drug's sales. It's sort of like a royalty in the music business; every time a song gets played, the artists who created it get a little cash. Royalty Pharma invests in both marketed drugs and those still in development.

Developed drugs provide cash right now, while drugs in development are more of a wild card. If they work out, there could be attractive royalties involved, but if they don't, well, the investment was a flameout. So, owning Royalty Pharma comes with some risks. However, it allows investors to get exposure to a diversified portfolio of drugs from a number of different drug makers with just one investment.

Right now, Royalty Pharma has investments in 35 approved products and 17 drugs still in development. One of the drugs to which it has exposure that's still in the development stage is Revolution Medicines' RASONQUE. Royalty Pharma estimates that this drug could generate up to $11 billion in peak sales and $340 million in royalties.

And that's just one of many drugs to which investors get exposure when they buy Royalty Pharma. But there's another angle here, too, since Royalty Pharma has a roughly 1.6% dividend yield. Many drug companies don't pay any dividends at all, including Revolution Medicines. So, Royalty Pharma is a way for dividend investors to gain exposure to drug development without forgoing an income stream. And the best part is that Royalty Pharma is filled with experts who are doing the hard work of cherry-picking the development drugs they believe have the best prospects for success.

Royalty Pharma is a good middle ground between risk and reward

Royalty Pharma's stock is up around 60% over the past year. That's not bad, but clearly owning Revolution Medicines has been more rewarding, given that stock's 330% gain over the same span. But there's a risk/reward balance that investors have to consider.

With Revolution Medicines, you are putting all of your eggs in one basket. If anything goes wrong on the drug development front, the stock could quickly crater if investor sentiment around the company sours. Royalty Pharma lets you spread your bets, providing a safer way to get exposure to Revolution Medicines' RASONQUE success. For many investors, Royalty Pharma will be the more attractive option.

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.