BUY AND HOLD. That's the investment philosophy most market gurus recommend -- and we at SmartMoney largely agree. There are plenty of stocks out there that you buy when you're young and pass on to your grandchildren. But the truth is there are many exciting market sectors where long-term investing just doesn't make sense. We're not talking about day trading here. It's just that companies in these volatile industries follow more or less predictable trajectories that savvy investors can exploit to their own advantage if they only knew how.

Case in point: generic drug companies. These more anonymous cousins of the big, brand-name companies like Merck and Pfizer typically command much more down-to-earth multiples. They also have the ups and downs of a manic depressive without his lithium tablets. But you don't have to be a psychopharmacologist to figure these potentially high-profit companies out. We decided to focus on one generic drug firm, Israel-based Teva Pharmaceutical Industries, as a case study in how to invest in this industry.

Lesson No. 1: Get 'Em While They're Cheap. Teva's shares are down 16% since January and 1998 earnings are expected to be down from the previous year. Yes, we know its recent performance makes it sound a bit like a dog, but Teva has a lot going for it. The company sells six of the 100 most prescribed drugs in the world -- and it is also starting to develop its own proprietary medications.

Lesson No. 2: Beware of One- or Two-Drug Companies. Just a couple of years ago, Teva was an industry darling. Its lead drugs Clonazepam, an antiseizure agent, and Sucralfate, which is used to treat duodenal ulcers, accounted for more than 30% of its U.S. generic business' bottom line. The drugs were highly profitable and investors had high hopes for a proprietary multiple sclerosis drug, Copaxone, that Teva was developing. But when these two generic drugs started to face increased competition, pricing fell from 20% less than the branded product to up to an 80% discount. And Copaxone didn't make up for the loss in earnings. As a result, the company missed earnings expectations in the fourth quarter of 1997 and in the first quarter of 1998. "Watch out for a profit balloon that can be popped," says James Flynn of ING Baring Furman Selz. Should this happen, as it did in Teva's case, "the stock can come crashing down."

Lesson No. 3: Catch 'Em on the Rebound. The good news is that Teva's earnings are poised to rebound in 1999. Although sales of its MS drug were slow at first, doctors are finally starting to feel more comfortable with it. They like the fact that it doesn't have some of the side-effects associated with other MS medications, such as flulike symptoms. Consequently, its growth prospects are increasing. Flynn estimates that Copaxone could contribute $1.5 million in the third quarter and $3 million in the fourth quarter.

Lesson No. 4: Make Sure the Pipeline Is Strong. The company also recently received FDA approval for a new generic version of Cataflam, a drug used to treat arthritis, which shares the nonbranded market with just one other company. This one is estimated to contribute five cents per share in the September quarter. While this is a relatively small product for Teva, the company's pipeline does look promising. It has 17 new compounds in the hopper, 16 of which do not currently face competition. Plus, Teva has access to part of Biovail's pipeline, as well. (Unfortunately, for competitive reasons, generic companies do not disclose what drugs they are working on.)

"The lifeblood for these companies is new products," says Ken Nover of A.G. Edwards. The number of drugs it has in its pipeline may not be a guarantee of future success. "[But] the level still gives you an indication of the company's activity," he explains.

Teva should also see some cost savings from economies of scale at other smaller drug companies it recently acquired in Europe. This could contribute up to $25 million. Add it all up, and analysts expect the company's earnings to increase almost 30% in 1999. And although Teva's shares have moved up 10% in the past few weeks, Robert Goldman of Josephthal & Co. does not believe the stock price reflects its future prospects. This company just rebounded with other small caps and Israeli companies. "It is more a function of it being up with the rest of the market," he says.

ING Baring Furman Selz's Flynn estimates that Teva's shares could reach $50 within the next 12 months. He came up with this number by using the company's historical P/E of 25 times, a valuation that is below Teva's estimated growth rate. That would be an increase of 26% from where the stock currently trades.

The toughest question becomes when to sell Teva and other generic drug stocks. Sorry, there is no rule of thumb here. You just have to keep watching the stock and exit it before earnings start to decline. We know, easier said than done. Our advice: If you start to make some decent money with a generic drug stock, don't be greedy. Manic-depressives can be incredibly charming, but only when they're not depressed.