How to Evaluate Investments in Biotechnology

Biotech can be an investment sector where you can become rich and it can be where you lose everything. Knowing how to evaluate investments in biotechnology can make all the difference. The rationale for investing in biotech is that a company will invent a new medicine or product that will change the world and generate huge sales in the process. The common reasons for avoiding biotech investments are that the vast majority of prospective products never make it to the market and that evaluating the prospects of a biotech investment can be very difficult to the point of bordering on guesswork.

However, there are a series of steps to take that will greatly improve you odds of success. Here are the basics.

  • What is biotech and what is not?
  • What is your risk tolerance?
  • What are the general risks of biotech and your investment in particular?
  • What should you be looking for in a biotech investment?
  • Check out the top biotech stocks as well as biotech ETFs.
  • Proceed with caution.
  • Keep close track of each individual investment.

Here are the specifics of our thoughts about how to evaluate investments in biotechnology.

What Constitutes a Biotechnology Investment?

Biotechnology means that the processes involve living (biological) organisms. A good example is the use of genetically altered e coli bacteria to produce human insulin. Although we usually think of biotech as being equal to the development of medications, the category includes things like genetically modified foods. Genetically engineered plants that are more resistant to diseases or chemicals fall into this category as well. The processes involved need to include the use of biological organisms.

And, the use of biotechnology needs to be a major part of the company you are investing in. While many large pharmaceutical companies work in biotechnology, the fractions of their work and profits are small. As such they are considered biotech investments.

Note: Because many investors mistakenly consider any small pharmaceutical startup company to be “biotech” the name may stick even as the company grows and does little or no work in the biotech arena.

When screening for biotech stocks, simply check the industry designation to make sure that a stock is biotech. For example, “Med-Biomed/Genetics” is a biotech stock designation. This means that the company works in biotech as its primary focus and source of profits.

What Is Your Investment Risk Tolerance?

If you are interested in investing in stocks without losing any money, the vast majority of biotech investments are not for you. Any investments in biotech that you make will be in established companies whose stock prices already reflect their success. Two ways to reduce your risks are these. Invest in ETFs that track a basket of biotech investments or invest in your own carefully selected group of biotech stocks and track them very closely.
Not paying attention in the biotech investment world is equivalent to throwing you money away.

Risks That Are Unique to Biotechnology Investments

Every biotech product starts with an idea. The company needs to efficiently and cost-effectively translate that idea into a product they can sell. In the medical product sector of biotech drugs need to work for the purpose intended, not cause any harm, pass strict clinical trials and have a large market to sell to. At any step along the way, a biotech drug may fail to pass a regulatory step. And, these drugs have limited exclusivity and patent protection so when these expire, other companies move in to make the same drug without having incurred the developmental costs.

Biotech meds typically come to an investor’s attention when a drug enters FDA clinical trials. This starts with “pre-clinical” testing which is done “in vitro” in the lab and with test tubes. It progresses to “in vivo” testing with animals.

Only after a drug has satisfied the first steps does it progress to “clinical” testing which is use in humans. The vast majority of biotech drugs never get this far.
In order for a drug to be OK’d for use in the USA, it needs to work and it needs to cause no harm. This is tested in three steps which also determine the appropriate dosage in people and the incidence and types of side effects. The success rates for drugs that get this far are as follows:

  • Phase 1: 37% pass
  • Phase 2: 30% pass
  • Phase 3: 60% pass
  • FDA approval: 85%

The stock prices of these companies may be particularly labile when results of phase 1, phase 2 and phase 3 testing are due.

There are many drugs that are perfect cures or treatments for rate diseases or diseases that are prevalent in poor countries where no one can pay for the drug. They get developed but they are never profitable and are commonly referred to as “orphan drugs.”

And, in the USA, Europe, Japan, and other nations, government run health care programs and insurance companies need to pay for the drug at a price that makes the whole process economically feasible. And, it all needs to work out before their period of exclusivity (12 years in the USA) and patent protection (20 years in the USA) run out.

What to Look for in a Biotechnology Investment

The safest biotech investments are companies that have products that are approved and making money and a “pipeline” of drugs and other products at all stages of development and regulatory approval. The company ideally has a good track record of picking ideas and bringing them to fruition in a reasonable period of time.

Ideally the company is making billions of dollars and its intrinsic stock value is such that it is an obvious buy. And, don’t be surprised to learn that such biotech investments do not exist. But, the best investments have a good product lineup, a promising pipeline, a strong financial position, and a fair price.

Predicting biotech success is chancy. Because many startup biotech stocks have one of two products in their pipeline and no guarantee of success, they are largely “story” stocks. The more you know about the details, the more secure your investment will be.

Although you may have no clue as to whether a drug in development will work out, there are folks who have more insight. When you see that a major pharmaceutical company has partnered with a small biotech startup, you know that someone with the right technical expertise is impressed.

In the end, the more you know about a sub-sector of biotech, the more successful you will be. This means that you focus on an area of development that you understand to a reasonable degree and then apply fundamental analysis to the degree that is possible.

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