How would you like to invest in a sector comprised of companies that have an 85 to 95% failure rate on everything they attempt to invent, their success or failure hinges on a government agency that has more mood swings than "that guy" at work and there's a significant chance that if you pick the wrong the company, you could see 90% or more of your investment disappear in less than 24 hours?
How's that for a glowing endorsement of the biotech sector of the stock market? If you're an investor in biotech stocks, you know of these realities, but you also know that when one of these companies markets a breakthrough drug, your investment can double over night. Here's what you should know.
More Than Just Drugs
In the popular investing circles, biotech stocks are thought of as companies that treat an illness, but they're bigger than that. Companies like Dendreon and Celgene do develop products to treat illnesses, but biotech also includes the production of genetically engineered seeds for agriculture, biodegradable plastics, biofuels and other industrial uses. However, most investors think of biotech as a high tech, 21st century version of the older pharmaceutical companies.
Traditional medical research has concentrated on using relatively simple molecules found by trial and error as a way to treat illnesses. Biotech companies may engineer or use more complicated methods, such as modifying proteins that attempt to disrupt the disease process. The traditional way of scouring the globe for simple molecules has given way to engineering living cells for the benefit of the patient.
The Biggest Enemy to Biotech
The biggest enemy, according to biotech analysts, is the Food and Drug Administration (FDA). Once a drug goes through a series of trials, the biotech company submits an application for approval. Those with experience in dealing with the FDA speak of an organization that may be very conservative during some periods and very liberal during others. The FDA may require further testing during its conservative periods, but may not do much more than rubber stamp a drug when it's in a more liberal mindset. It may also be more willing to approve applications for drugs that treat diseases without a cure or acceptable treatments.
The New Landscape
The business of pharmaceutical companies is changing. Companies that used to employ teams of scientists to find the next big blockbuster drugs are transitioning to the business of purchasing smaller research companies, or the drugs they produce. For instance, in 2006, large pharmaceutical companies spent roughly $17 billion on more than 250 biotech firms. By purchasing companies already in the process of developing new treatments, the pharmaceutical companies can focus their finances towards other endeavors, such as marketing. They take on only the risk that the drugs fail in the market, instead of the 85 to 95% risk that the drug never reaches the market at all.
Biotech watchers are applauding the recent passage of the Faster Access to Specialized Treatment or FAST Act, which speeds up the process by which drugs for diseases without a cure come to market. This legislation is designed to speed up the development of personalized treatments for patients suffering from life threatening and serious diseases, and may provide an incentive to biotech companies to invest even more in research and development, if they know that they can potentially recoup their investment at a faster pace.
The Bottom Line
Biotech companies are difficult to research because of their relatively small size. Since they often do not have any cash flow, and investors are provided little indication of the status of their research, big announcements frequently come by surprise. Investing in these stocks can be a long waiting game; it can pay off big or the investor may lose most of their position.
For the retail investor with little time to research the sector, investing in a biotech exchange-traded fund may be the safest way to commit funds to the sector, but for those with a passion for due diligence, the sector can prove very profitable.