How to make money in biotech stocks

For example, Paul caught Ariad Pharmaceuticals on Sept. There are four phases in approval, and a Phase 3 or 4 drug should be worth a lot of money. But every now and then, we see Phase 2 and 3 drugs at Phase 1 prices. On Jan. PBYI surprised investors when they reported positive results for their Phase 3 cancer drug neratinib. Watch for the signal on Dec. The potential gains without the leverage are extraordinary. Diana Gordon for The Daily Reckoning. The sector is roaring with gains across the market.

Seven simple steps to improving your chances of success in this part of the market.

Advertiser Disclosure. Smart investing in biotech can actually be rather lucrative. Here you will find some legitimate tips for helping you avoid some of the usual pitfalls and earn a tidy sum investing in the biotech industry. It is safe to bet that unless you have a Ph. To take advantage of their expertise is to check where they are placing their money. For example, Celgene shares a very strong bond with Juno Therapeutics at this juncture. Small biotech companies are actually losing money. If you invest in a clinical-stage company, you are essentially investing with the hope of receiving a share of the potential future revenues, and you should be aware that profitability is still not there yet. That is not necessarily a negative. One of the greatest reasons why the share prices of biotech companies fall is shareholder dilution. If you wish to protect yourself, you need to calculate the cash runaway by dividing the amount of cash available to the company with its annual expenditure. If you find the result to be less than a year, it is a strong sign that dilution will soon come up. A good example is MannKind Corporation , which is a company that has had multiple rounds of share offerings each increasingly diluting its shareholders as it continues struggling to market the only drug it has, which is an inhaled insulin known as Afrezza. The shares recently dropped a whopping 27 percent in one day upon the announcement of yet another round of shareholder dilution. The move would have been hardly surprising to those keeping an eye on its cash level. Even the management made it quite clear that its cash reserves were only enough to keep the lights on until the end of The biotech industry is full of emotion and it is not hard to see why: It is all about companies with the potential to ease human suffering and save lives. It is also an industry that attracts an incredible number of investors that are sometimes greedy. Whether the emotions are genuine or not, the industry is still volatile. Investment advisors usually keep tabs on all the publicly traded and reasonably sized companies and if one moves 10 percent in either direction up or down , they usually write an article to explain the reasons why.

1. Know which stocks are biotech stocks — and which aren’t

Investing in biotechnology can be a risky business. The following list outlines some suggested criteria to consider when choosing which biotech stocks to buy. Watch for companies researching areas such as cancer, AIDS, diabetes, heart disease, neurological diseases, immunological diseases, viral infections and tissue regeneration, where there is a high degree of incidence in the population. An alternative is to invest in a niche company with an orphan drug that, if successful, is protected from competition for several years. A strong network of collaborative support is an indication that a company is financially and logistically stable. A small company, despite having good ideas, might find it difficult to go it alone, but can benefit immensely from the backing of one or more larger corporations. Several sponsors provide added security since the withdrawal of support from one collaborator might result from missed milestones, strategic differences or a general loss of interest in a project. Some financial advisors say to select companies with at least 2 years of cash reserve. It takes many years to license a product, however, and even longer to recoup the costs of developing it. There are many different options for financing a startup , so investigate new companies carefully. It’s also important to consider where more established companies get their funding, and whether there is potential for more if needed. For publicly owned companies, you must judge whether they have excessively diluted their shares. Look for a company that hasn’t already taken out excessive loans, from banks or private investors, to get started.

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All of these adjectives apply to investing in biotech stocks. The excitement and the prospects for generating huge profits make biotech stocks appealing to many investors. On the other hand, the fear of big losses that stem from the high risk levels associated with many biotech stocks causes other investors to stay away. How should you go about investing in biotech stocks? There are seven key steps to follow that should improve your chances of success:.

First, you’ll want to know which stocks actually are biotechs and which aren’t. It’s not as easy as you might think. Biotech is short for biotechnology, a term that references any technology that incorporates biological organisms. But while many big pharmaceutical companies develop biologic drugs now, they aren’t how to make money in biotech stocks viewed as biotechs.

That’s primarily because these companies make most of their revenue from sources other than biologic drugs. Also, some drugmakers are typically classified as biotechs even though they don’t make most of their money from biologic drugs.

A lot of people call any small drugmaker a «biotech» regardless of whether the drugs it develops use living organisms. Even when these small companies grow to be large, they’re still called biotechs. If you’re looking to invest in biotech stocks, there is one quick way to determine which stocks are biotechs and which aren’t. You can check out the industry designation for the company on investing sites. On Fool. Perhaps the most important step of all with investing in biotech stocks is to determine your risk tolerance.

Some investors are aggressive and can tolerate higher levels of risk. Others are more conservative and seek to minimize their risk levels. There’s a big reason you’ll want to know your risk tolerance: It will help you determine which biotech stocks are good investing candidates for you and which aren’t.

If you already know your risk tolerance, great. If you don’t, you might want to complete a risk-tolerance questionnaire to help you determine your investing style. All stocks have risks. But biotech stocks have some specific risks that aren’t applicable to stocks in many other industries. The risk of clinical failure. Probably the most critical of these biotech-specific risks is the potential of failures in clinical trials.

All biotech companies must thoroughly test their experimental drugs to assess the drugs’ safety and efficacy in treating the targeted condition. This process starts with preclinical testing. Some preclinical testing is conducted in vitrowhich literally means «in the glass. Other preclinical testing is done in vivowhich means «within the living. Biotechs that only have experimental drugs in the preclinical stage are especially risky. Most drugs never advance from preclinical testing into clinical studies.

If a drug looks promising in preclinical testing, though, the biotech can seek regulatory approval from the Food and Drug Administration FDA in the U. The primary purposes of phase 1 clinical studies are to evaluate the safety of an experimental drug, including identifying possible side effects, and to determine the ideal dosage range for the drug. The successful drugs advance to phase 2 clinical studies.

The ones that are move to phase 3 clinical studieslarge clinical trials needed to assemble sufficient statistical data that the drugs are both safe and effective. Regulatory approval setbacks. Biotechs still face the risk that drugs that have been successful in clinical studies won’t win regulatory approval.

In some cases, the biotech can conduct additional clinical studies to persuade regulatory agencies to approve an experimental drug. However, frequently a regulatory rejection means the end of the road for a drug. Commercialization problems. You might think that once its drug wins regulatory approval, a biotech has it. Not necessarily. Companies must persuade insurers and government healthcare programs to pay for a new drug. In the U. In Europe, biotechs must negotiate with each country individually for a new drug to be covered.

On top of these negotiations, biotechs must build sales teams to promote new drugs to prescribers. In many cases, companies also market directly to consumers via online, print, and TV advertising. Despite all of these efforts, there are significant risks that a biotech will be unsuccessful in achieving commercial success for a new product.

While biotechs often compete against other drugmakers, they enjoy protection for a while from potential rivals seeking to market generic or biosimilar versions of their drugs. Biologic drugs receive a year period of exclusivity from biosimilar competition, while non-biologic drugs typically have a five-year exclusivity period. In addition to the exclusivity periods, biotechs usually secure patents on their drugs.

These patents expire 20 years after the filing date. Once a biotech’s drug loses exclusivity and patent protection, rival companies can legally launch «copycat» versions of the drug. This nearly always causes a sharp decline in sales for the biotech’s drug. The perfect biotech stock to buy would be one that has a broad lineup of approved drugs on the market. Each of these drugs would generate billions of dollars in annual sales.

They would have a long way to go before the loss of exclusivity or patent expiration. And they would enjoy virtual monopolies for the conditions they treat.

This perfect biotech stock would also have a deep pipeline with a lot of candidates in phase 3 testing. The company would be super-profitable with fast-growing revenue and a mountain of cash built up to use in rewarding investors through share buybacks and dividends. And the stock would be dirt cheap. Unfortunately, such a biotech stock doesn’t exist. The closer a given biotech stock rates on each measure, the better investment choice it should be.

Many small biotechs won’t have any approved drugs. For the biotechs that do, companies with multiple drugs with strong and growing sales will be less risky than. It’s also a good sign when a biotech has best-selling drugs in multiple therapeutic areas. Diversified revenue sources are nice to have with any stock. Pipelines can be difficult to evaluate. However, a pipeline that has several drugs in late-stage testing is preferred because they have less risk than experimental drugs in earlier-stage development.

You can also check out what analysts and other industry observers have to say about early stage clinical results to get a sense of whether there are any yellow flags with what might otherwise seem to be positive results. Established biotechs will have stronger financial positions than small clinical-stage biotechs. Strong revenue and earnings growth is a big plus.

Regardless of the size of the biotech, though, look at the company’s cash position. A small biotech with no approved products could have to issue new shares if it doesn’t have enough cash, which causes dilution in the value of existing shares. Think of a pizza with eight slices that’s cut into 16 slices.

Anyone who had a slice initially has less pizza to eat after the second slicing. With larger biotech stocks, you can use traditional metrics such as price-to-earnings and price-to-earnings-to-growth PEG ratios to assess valuations. The key here is to compare these valuation metrics for a given biotech stock against its peers to determine whether it’s relatively cheap or relatively expensive.

The valuations of smaller biotech stocks with no approved drugs are tied to what investors think about the biotechs’ pipeline prospects. It’s difficult to know how reasonable the growth prospects are for pipeline candidates that haven’t been approved. One important thing you can look at with small biotechs, though, is any partnerships that they have established with larger drugmakers. A major drugmaker wouldn’t partner with a smaller biotech without performing due diligence on its pipeline candidates.

Having a big partner doesn’t mean that a small biotech’s pipeline isn’t risky, but investors can usually have more confidence in a small biotech’s pipeline candidate when a major drugmaker has put significant money on the line betting on the success of the experimental drug. These are the exceptions. There are hundreds of biotech stocks with much smaller market caps. In addition, several biotech ETFs are available that hold positions in many individual biotech stocks.

Your risk tolerance will dictate which of these biotech investment alternatives are the best fits for you. To give you a sense of how to evaluate biotech stocks and ETFs, we’ll look at a few examples that might appeal to investors with different risk tolerances. Note that there are no options provided for investors with low-risk tolerances. Biotech stocks and ETFs probably wouldn’t be well suited for these investors. Alexion Pharmaceuticals. Alexion currently has four approved products, all of which target rare diseases.

Sales are climbing for all four of Alexion’s drugs, with tremendous growth for its newest product, Ultomiris, which market researcher EvaluatePharma thinks will be the biggest new drug launch of The biotech’s pipeline includes three late-stage programs targeting rare diseases. In addition, Alexion has four early stage clinical programs. Alexion appears to be in a strong financial position. Its revenue and earnings continue to grow rapidly.

The company also has a substantial cash stockpile that it can use to reward shareholders through stock buybacks or to make strategic business development deals to fuel growth.

1. Know which stocks are biotech stocks — and which aren’t

I previously posted about using stock trading to make some relatively passive income. Today I wanted to briefly discuss a particularly profitable form of stock trading — buying biotech stocks. Biotech companies are often pharmaceutical drug companies — these organizations can go from a tiny evaluation to being worth hundreds of millions of dollars on the invention of a single useful drug. Disclosure: Please note that some of the links on this page are affiliate links. This means that we may earn a commission, at no cost to you, if you decide to make a purchase after clicking through the link. Please understand that we have experience with these companies, and we recommend them because they are helpful and useful, not because of the small commissions that we may receive if you decide to buy something through our links. I first came across Kyle Dennis a few years ago when I was looking for a way to make some extra money between real estate deals. Here is a free masterclass that he runs to help other traders learn his profitable trading strategy! Many people understand that this provides a potentially massive wealth generation opportunity. If you purchase a stock of such a company and they produce a new cancer drug which gets FDA approval — you will most likely make a fortune as the stock price of the company soars. Wouldn’t it be nice to know the exact date that such a significant announcement for a new drug FDA decision is likely to be announce? Well it is all public knowledge! So my strategy is to purchase the stock of a biotech company a few weeks before the expected catalyst date. It takes some patience but as the announcement date approaches, many people will but the stock, if they think that the decision is likely to be positive, which causes the stock price to rapidly increase even before any actual news hits. These people are often trying to hit that moon shot where they make a massive amount of money very quickly.