Investing in biotech stocks isn’t for the faint of heart, but with a little research, patience and luck, these can be some of the most lucrative equities on the market.
For a bit of background, biotech companies create cellular and molecular technologies to improve our collective health. Those technologies range from medicine to agricultural advancements and even certain niche industrial applications.
The success of a company depends on many different factors, but the ultimate goal of any biotech firm is leveraging the power of science to tackle a (hopefully lucrative) problem with sufficient demand for a fix.
Determine your Risk Profile And Systematize Your Approach
The biotech sector can be particularly risky: the average time for a biotech company to bring a product to market is 10 years! And in addition to long development periods, investors are subject to extreme volatility, with no certainty of upside or completion of drug development.
As a result, knowing your own personal risk tolerance and having a systematic approach to investing is key. Only about 10% of all prospective new drugs go on to be approved and put into production.
With that in mind, retail investors can set realistic expectations and maximize profits over time. Persistence, research and proper due diligence are your best friend when investing in these stocks. Once an investor understands the risks associated with biotech investments, the door to asymmetric upside is opened. Here are some notable examples of outperforming biotech stocks in 2021 and their YTD returns:
- KemPharm (NASDAQ:KMPH) — 1,736% YTD
- Cassava Sciences (NASDAQ:SAVA) — 1,356% YTD
- Onconova Therapeutics (NASDAQ:ONTX) — 1,183.81% YTD
- Novan (NASDAQ:NOVN) — 1,015% YTD
Those are astounding returns, enough to make anyone green with jealousy. So it’s no surprise that investors are eager to try and pick out the next biotech stock to skyrocket.
You Don’t Have to be a Scientist to Conduct Due Diligence
While it would be wonderful if everyone was fluent in scientific jargon and able to sift through the latest research paper from their company of choice, it’s just not realistic.
In fact, most retail investors feel lost on where to even begin the due diligence process when looking at biotech companies to buy. Below, we’ll list some basic steps for researching biotech firms. But first, here’s the TL;DR abbreviation:
Red Flags
- Excessive/unnecessary updates with little concrete progress (press releases, skewed trials, etc.);
- Primary endpoint failure in clinical trials; overenthusiasm around secondary endpoint success despite inability to meet the primary; and
- Unexpected executive departures.
Green Flags
- 75%+ of shares are held by institutional investors;
- Exclusive intellectual property and patent protection; and
- Reputable collaborations and licensing deals.
Start With the Team
Plenty of revolutionary technologies have failed due to poor execution and weak management. It’s important to get familiar with the individuals who are “steering the ship,” especially when they’re guiding the development of a technology that quite literally doesn’t exist yet.
A great place to start is with the employment history of key management figures. If the C-suite is filled with individuals who from companies that previously succeeded at pushing drugs through FDA approval and onto the market, that’s a great sign. Teams with experience have a much easier time adapting to the many challenges of the pre-product biotech industry, including high research and development costs, intellectual property battles and economies of scale.
Consider the Product Pipeline
A company with a moderately full pipeline is a great indicator of a company primed to succeed. The key word here is moderately: a company overloaded with drugs in development can get bogged down and end up down the line with no approved candidates for sale on the market. But companies relying on just one drug to be approved can see their stocks quickly demolished if years of work prove ineffective or unsafe.
Due to the high level of expenses that are required to bring a drug to FDA approval, the product pipeline and where management allocates resources is of critical importance. Mismanagement of funds in this early stage can be a fatal mistake leading to extreme losses for shareholders.
What Does the Runway Look Like?
If you can’t tell, financial management is extremely important in pre-product biotech companies. One key metric to consider is the company’s cash runway.
A company that struggles for funding, fails to close deals and lacks institutional investor interest will likely see their money dwindle to nothing. Cash positions and burn rates can be used to estimate the length of time a company will be able to operate without outside intervention. And when deals do happen, up-front cash from investors is a sign of confidence to look out for.
Don’t Forget the Science, But Do Keep It Simple
Formal due diligence requires an understanding of the science behind a drug’s development, but low-level inferences can be made based on a few factors. If a company is developing a novel drug for a disease with ample demand, it would be reasonable to say that it’s a worthwhile financial pursuit, especially if they have a first mover advantage.
On the other hand, a brand new company that seeks to develop a drug that already has existing, reputable competitors may not have the expertise or funding to create a superior solution. Clinicaltrials.gov is one great source for investigating the efficacy and progress of a drug in development.
Biotech Stocks are “high risk, high reward” plays that typically require extensive knowledge and analysis to make accurate predictions, especially because the industry is volatile and impacted by many different factors. That said, an investor can analyze a company’s team, pipeline, funding, patents and partnerships to make an educated investment in those biotech stocks most likely to be profitable in the future.
By following a plan that aligns with their risk profile and incorporates a fundamental analysis of these factors, investors can maximize their chances of booking big profits with biotech stocks.
Kiernan Fitzsimons is a Benzinga writer and InvestorPlace contributor.
