If investing Foolishly requires patience, then investing in health care stocks requires the discipline of a monk. In a sector so dominated by short-term catalysts, where classical rules of valuation and long-term growth are difficult to apply, it is hard to subdue greed and fear to make patient and educated investment decisions. How then can we maintain sanity in the face of wavering stock prices and a bombardment of news headlines? The answer is simple: have a plan.
Unlike most other sectors, the importance in health care of binary events such as Food and Drug Administration decisions or meeting clinical trial endpoints cannot be overstated. Thinking critically about these events in advance can save you a lot of aggravation when crunch time hits and can help preserve sanity in a rapidly evolving market.
Short-term catalysts run the show
Take, for example, the 18% drop in Gilead Sciences' (GILD 0.91%) stock from around $27 per share to $22 per share in February 2012. The stock fell over two trading days when it announced that its promising hepatitis-C drug sofosbuvir had failed to prevent viral relapse in most of the patients in one arm of a large clinical trial. Without an escape plan, the bad news and 18% drop could have scared anyone out of their investment.
What the drop in share price didn't tell you, though, is that this arm of the phase 2 ELECTRON trial was very small, with only 10 patients suffering from an extremely difficult-to-treat variant of the disease. The drop also didn't tell you that the other arms of the study were providing exceedingly impressive results supporting the use of sofosbuvir in other HCV indications. It also wouldn't tell investors that Gilead was planning additional trials for the difficult-to-treat indication with sofosbuvir and its own companion drug, ledipasvir. In total, Gilead's sound financial footing, established HIV franchise, and comprehensive development program allowed it to overcome disappointing data, submit a NDA for sofosbuvir under several indications, and send its stock price soaring 180% since the decline.
On the contrary, take the recent plunge of Prosensa (NASDAQ: RNA). Prosensa sat at a market cap above $800 million on excitement over its exon-skipping technology for the treatment of Duchenne muscular dystrophy. But when a phase 3 study of drisapersen showed no significant improvements to walking ability or other metrics of motor function, the stock crashed 70%. Unlike sofosbuvir's limited trial miss, the drisapersen failure is a major hit to the company's growth prospects, and investors were right to run for the hills. The stock now sits at a market cap of around $240 million, down half of a billion dollars with the fate of its other programs and exon-skipping technology in question.
By comparison, Prosensa's big pharma partner GlaxoSmithKline (GSK 1.22%) barely budged on the news, as investors recognized the limited impact of one trial miss in the scope of a diversified pipeline.
Set your plan in advance
The only way to overcome a natural impulse to react when short-term catalysts send the value of your investment to new heights or painful lows is to have a preconceived plan. Playing some investing chicken can help you be prepared when the market overreacts to an earnings miss or a trial setback. Assess the impact of these events on the value of the company and its prospects for sustained growth. Don't be scared or influenced by swings in the stock price if you do not consider the underlying catalyst vital to your investment thesis. Think big picture, think long term, and think Foolishly.
