Is it ever “safe” to buy biotechs? These are some of the most volatile investments on Wall Street — able to make or break your portfolio overnight.
For starters, let’s be honest about most biotech stocks. They’re simply launching pads that in a best-case scenario see their innovative drugs pass clinical trials with flying colors and win FDA approval, causing the stock to blast off. Then shortly after, Big Pharma comes knocking with a buyout that sends the stock screaming even higher.
Worst-case scenario, on the other hand, is a failure of the new treatments that results in the company blowing up on the launch pad.
The result can be either huge profits for investors or a painful loss. There’s rarely a middle road.
Understand this first and foremost: Biotechs and upstart medical device stocks are a risky game.
Second, remember that buyouts are the name of the game — so rumors constantly circulate with varying degrees of truthfulness. Unscrupulous investors may be simply looking to “pump and dump,” so always take everything with a grain of salt.
That said, buyouts happen — and can deliver big profits when they do.
Take Human Genome Sciences (NASDAQ:HGSI), bought out by GlaxoSmithKline (NYSE:GSK) for $14.25 a share after trading as low as $7 just weeks before the deal. Or Amylin Pharmaceuticals (NASDAQ:AMLN), bought by Bristol-Myers Squibb (NYSE:BMY). The Amylin-BMY deal kept creeping up before finishing at $31 a share, providing a quick doubler for AMLN shareholders.
These are the dream stocks. But don’t forget the nightmares out there.
Those are companies like MAKO Surgical (NASDAQ:MAKO), which is down 41% this year, back to 2010 valuations, as its technology for knee-replacement surgery hasn’t panned out as investors planned. Other flops include Dendreon (NASDAQ:DNDN), down 35% year-to-date, and Progenics Pharmaceuticals (NASDAQ:PGNX), which lurched down about 50% just a few weeks ago.
There’s nothing inherently wrong with biotech investing, but unless you’re willing to do the legwork on FDA trials and medical studies, and unless you have a good knowledge of science to fully comprehend how the drugs work and what they treat … well, I’d steer clear.
Small-cap biotechs are exciting because of the profits they can deliver. But if you’re a novice with no medical background and no interest in getting lost in journal articles on genetic disorders, you’re better served investing in a safer and more accessible corner of the market.
But if you don’t mind the risk and relish the research, there are big profits to be had — particularly if a hit drug makes your holding a buyout target. That’s the ultimate payoff for a biotech investor.
Just beware that if you’re reading the rumor on Seeking Alpha or TheStreet.com, some of the buyout hopes may already be priced in as a premium … and if it doesn’t happen, you’ll be left holding the bag.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.