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Mention the word "biotechnology" and the average person gets a little nervous and apprehensive because biotechnology is not an easy industry to define with all its "hocus pocus" of scientific jargon. Biotech companies employ highly diverse research techniques such as monoclonal antibodies, antisense oligonucleotides, carbohydrate technology or gene therapy, just to name a few. While no two biotech companies are alike, all share an emphasis on the use of genetic engineering and the manipulation of organisms at a molecular level to develop new products. The biotechnology sector is an innovative and growing industry. Back in 1982 the sector had virtually no products, now biotech firms have successfully commercialized over 30 products, with nearly 10 times that number still in clinical trials. Biotech companies have introduced many new drug products, but many biotech firms are still in the developmental stage, with their fortunes largely determined by investor perceptions of the relative merits of their research and development pipelines. In addition, the endeavors of biotech research have extended beyond the field of medicine to other fields, such as agriculture, energy, and environmental protection.
How does an individual investor analysis a company with no revenues and no products? How is one to access the quality of research in such a technical and specialized field?
One of the most striking aspects of the biotech industry is its scarcity of earnings. Most biotech companies carry losses for years, even after they have launched a new product. As a result, valuing biotechs is a precarious undertaking at its best. The details of a biotech firm’s business, its research methods, its test results, even the products themselves, can be highly complex. The success or failure of a drug during clinical trials is difficult and often impossible to predict.
Investing in biotechnology stocks is somewhat unlike other investing stocks because in valuing biotechnology stocks, it has always been difficult to use traditional net present value and discounted cash flow approaches, particularly for the clinical and pre-clinical stage companies. Predicting the probability of a single product's success in the clinic depends on many variables such as clinical trial design, difficulty of indication, and quality of Phase II data. In addition, the company's financial well-being and corporate partnerships may further complicate the valuation analysis. The large cap and profitable biotechnology companies have had the broadest appeal to investors, but that is only a handful of companies. Investors in biotech stocks take a long term approach to investing. There are stocks that can significantly appreciate in value overnight if a trial is successful. Conversely, they can also drop by 30% to 70% in value with disappointing results. Biotech companies’ stocks tend to be heavily influenced by favorable or unfavorable news regarding the development or testing of a product.
Here are some guidelines and insight of what to look for when evaluating and investing in biotech stocks.
Product Pipeline: Look for companies with at least two drugs in clinical trials. Because if for some reason the product proves to lack efficacy, then at least the company has something to fall back on. Another approach is to look for companies diversified around a specific disease class or that have a niche technology that can be used as a platform for a range of different drugs.
Collaborations: Companies that fail to link up with a corporate or academia partner can have trouble surviving. To ensure survival or lower risk, biotechnology companies will engineer several collaborative agreements with various pharmaceutical companies for research or marketing. Look for substantial milestone payments and cash commitments when the deal is announced, not just "talk" about a research alliance. For example, Abgenix has made a number of deals with biotechs and pharmaceuticals for licensing its XenoMouse technology for making humanized monoclonal antibodies that are worth hundreds of millions of dollars.
Management: For early-phase companies, they may or may not have the presence in senior management of someone with a proven track record of taking a drug through the regulatory hurdles and/or to the marketplace, but look at their financials and go to the section on management to see who’s working there and what they’ve accomplish in the past.
Cash: For many biotech companies, the release of a commercial product is often many years away and requires millions of dollars. Thus, a company’s burning of cash in ongoing research and development or "burn rate" is a critical measure of a company’s longevity. Look for companies that have a minimum of two years’ cash reserves.
Market: Medical advances mean more people around the world are living longer, but their bad habits mean they aren’t necessarily living healthier and happier lives. The so-called diseases of the rich - cancers, heart attacks, strokes and other illnesses in which diet and exercise are often believed to play a part - will increase as the customs of industrialized nations spread around the globe. Thanks to medical progress, life expectancy is averaging 64 years in developing countries and reaching 80 years in some industrialized nations. As a result, trying to improve the health of the aging baby boomers is of crucial economic importance. In the next 25 years, the population of people older than 65 is likely to grow by 82%, compared with 46% in the working age population and only 3% in newborns.
Genomic companies will prove to be invaluable to determine the causes of diseases such as cancer. Cancers killed 6.3 million people in 1996, and there were 10 million new cases - not all of them fatal. This expected to at least double in most countries in the next 25 years.
Look for biotechnology companies that are developing products aimed at markets for a new drug that is both large and underserviced. While an effective treatment for acute respiratory distress syndrome would be a substantial breakthrough and achieve overnight success, it’s hard to get enthused about yet another asthma drug because current treatments are satisfactory.
Another key factor in a drug’s success is how frequently it’s likely to be prescribed. Drugs that are used to treat chronic conditions such as the afflictions related to aging or AIDS, will generate a lot more cash flow than infrequently used treatments like vaccines.
Technology: Deciphering a biotech’s research methodology is not an easy task to do. So when evaluating a biotech company, the individual must look to see if the research and development can do what it needs to do and supposedly solve a medical problem or problems.
We at BioTech Sage Report believe that when you buy and own stocks you are buying a piece of the company, not the market, investing for long-term growth; day to day fluctuations will come and go. We see sound fundamentals for the biotechnology sector based on the fact that companies are pumping more money into research and development, positive clinical data, demographic health trends and the recent passing of a bill to speed FDA approvals
Investing in biotechnology stocks is not for everyone and is best suited for risk-tolerant investors seeking above-average capital gains for long term investing. The biggest returns and risks come from getting into companies in preclinical trials, while the most secure investments are in companies that are well into clinical trials with strong marketing alliances, but the upside, however, may be limited.
Biotechnology can possess a magical effect on investors and with the right companies, you are investing in tomorrow.
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