3 Investment Lessons From Biotech's 2012 Failures

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Some biotechs have had pretty good years. The iShares Nasdaq Biotechnology Index (NASDAQ: IBB  ) is up 33% year to date, nearly doubling the broader Nasdaq market that's up 18%.

Others, not so much.

Sure, 50% (or more) haircuts hurt, but there are lessons to be learned in the failure. As they say, "fool me once, shame on you. Fool me twice, shame on me."

Phase 2 is key
Predicting clinical trial results is hard. It's made harder when companies make changes between trials.

Aeterna Zentaris (NASDAQ: AEZS  ) and Keryx Biopharmaceuticals (NASDAQ: KERX  ) , for instance, ran a phase 3 trial testing their cancer drug perifosine on patients with advanced colorectal cancer. In the phase 2 trial, only a subset of those patients had the characteristics of the patients entered into the phase 3 trial.

The companies were basically testing the proof-of-concept idea in a large expensive phase 3 trial. It didn't work out so well. Shares of both Aeterna and Keryx crashed and burned.

Investment lesson: Recognize any changes a company makes between phase 2 and phase 3 and make sure you understand how that might affect how the phase 3 results.

Safety matters
Phase 1 clinical trials are supposed to highlight safety issues with new drugs. But not every side effect can be caught in the small trials.

That issue is made worse for indications, such as hepatitis C, where efficacy can be measured fairly well in phase 1 trials, making it tempting to not worry about safety. That's what happened with Bristol-Myers Squibb's (NYSE: BMY  ) BMS-986094. A phase 2 trial turned up some nasty side effects for the hepatitis C drug, sending shares down 9%, which is pretty substantial for a large pharma.

Idenix Pharmaceuticals (UNKNOWN: IDIX.DL  )  ended up getting caught as a bystander when the FDA decided its hepatitis C drug IDX184 was related enough to BMS-986094 that it should be put on hold until the agency could work out the potential issues.

Investment lesson: Biotech investing is risky. There are some unpredictable aspects that can't be controlled. Make sure the upside justifies the risk.

Just forget it
There are some diseases that investors should just stay away from. In 2012, the lesson was to stay away from Alzheimer's disease. Both Eli Lilly's (NYSE: LLY  ) solanezumab and bapineuzumab -- being developed by Johnson & Johnson (NYSE: JNJ  ) , Pfizer (NYSE: PFE  ) , and Elan (UNKNOWN: ELN.DL2  )  -- failed in phase 3 development this year.

A drug that slows the progression of Alzheimer's disease could be an instant blockbuster. But we just don't know enough about the basic science of Alzheimer's disease to know whether the drugs will work. It's unwise to risk money when you don't know the likelihood of success.

Sure, there's money to be made on the long shots as witnessed by the astronomical increase that Human Genome Sciences experienced as it got its lupus drug approved, but I seriously doubt that if you had bet on all the lupus drug developers that failed to create a new treatment for lupus over the last half century, Human Genome's success would make up for the losses.

Investment lesson: Some diseases are best watched from the sidelines. You might miss out on some substantial gains, but the high risk of failure is only appropriate for a small amount of your portfolio. Or you could just use on a trip to Vegas.

Foolish final thoughts
There's no doubt that biotech is risky. But investors can reduce that risk by understanding history. It often repeats itself.

If you need a little cheering up after reading about failures, check out the corollary article covering investment lessons from biotech's 2012 successes.

Also, if you're looking for stock ideas heading into the new year, The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock in our brand-new free report: "The Motley Fool's Top Stock for 2013." I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this under-the-radar company.


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