Investing in the stock market is a gamble. We can only use the facts we are given in the form of quarterly reports, hope that they're accurate, and use our collective knowledge to determine if an equity is worth our hard-earned money. If the stock market is like a casino, the biotechnology sector is, without question, the roulette table.
The deck is significantly stacked against investors since considerably more drugs will fail than will succeed. But success can mean huge returns. Take Human Genome Sciences (Nasdaq: HGSI ) and Vanda Pharmaceuticals (Nasdaq: VNDA ) , for example, which are up 285% and 105%, respectively, in the past three years, following FDA approval of their leading drug candidate. But not everything that soars in the biotech sector turns out to be a great investment.
More often than not, companies will crash and burn because investors' emotions take precedence over the real weakness exhibited in a company's pipeline. In just the past month, Transcept Pharmaceuticals and Nabi Biopharmaceuticals (Nasdaq: NABI ) have plunged more than 50% following unfavorable FDA and clinical trial results. Keeping this in mind, consider yourself warned about investing in the following two potentially dangerous biotechs: Pharmasset (Nasdaq: VRUS ) and Ariad Pharmaceuticals (Nasdaq: ARIA ) .
Buyout speculation has fueled Pharmasset shares to an all-time high and a stunning market value of $4.8 billion -- even though the company has no marketable drugs to date.
The company's focus is on finding cures for hepatitis C and HIV, but it does not yet have a single drug candidate past phase 2 clinical trials. Working in collaboration with Roche, Pharmasset is betting the house on success with RG7128, the lovable name assigned to its hepatitis C drug. Thanks to its partnerships, cash constraints aren't an issue, but results definitely are. At what point do investors take notice that Pharmasset doesn't have a drug past phase 2 trials regardless of the current lack of competition in the hepatitis C market?
The stock is up a staggering 429% over the past year on hopeful results from its early stage trials, but it all means nothing until it gets the FDA's stamp of approval. At these stratospheric levels, and no product revenue to speak of, I feel speculators are playing with fire.
Ariad Pharmaceuticals, like Pharmasset, has reached a lofty valuation of $1.7 billion without having a marketable drug as of yet.
The company's primary focus is on cancer solutions through its three primary drugs, ridaforolimus, ponatinib, and AP26113. Between Ariad's three main candidates and the 13 clinical and preclinical trials currently being explored, only one has made it to the phase 3 stage. In short, an FDA rejection of ridaforolimus at this point could do serious damage to shareholder value, especially considering that the stock has rallied 327% in the past year.
Ariad currently generates all of its revenue from partnerships, specifically with Merck (NYSE: MRK ) . While Ariad does get the experience of having Merck on its side, it's unclear what percentage of royalties Ariad would receive if ridaforolimus were approved. In sum, there are still far too many unanswered questions to justify a $1.7 billion valuation.
The house always wins
Always remember when you're gambling in casinos that the house always wins. Investors have thus far been greatly rewarded with the returns in Pharmasset and Ariad, but realistically, without tangible evidence of a marketable drug in the very near future, these two could be in for a rough road ahead.
Would you take a gamble on either of these two biotech bottle rockets? Share your thoughts in the comments section below and consider adding Pharmasset and Ariad Pharmaceuticals to your watchlist to keep up to date on the companies.