Know Your Drug Stock ABCs: Part 3

Investing in the pharmaceutical and biotechnology industries can be difficult, given the many technical definitions an investor needs to know. To make understanding these companies easier, and perhaps to serve as a handy reference guide, this three-part series covers some of the terms and definitions needed to invest in these sectors.

While the first and second articles covered terms used in the regulatory processes and clinical trials, this article will look at some of the general words and terms used throughout the biotech and pharmaceutical industries.

Biologic drug: A therapeutic drug manufactured from living organisms using biotechnology. A good example of a biologic would be Genentech's (NYSE: DNA  ) cancer treatment Avastin, or Amgen's (Nasdaq: AMGN  ) Enbrel, which is used to treat arthritis.

Since biologics must be grown with a medium like bacteria, or even inside live goats, manufacturing them is much more expensive and difficult than other pharmaceutical products.

Biotechnology: Not all companies using biotechnology develop biologic drugs. Biotechnology is the purposeful manipulation of living organisms for a particular application. It can be used in all sorts of diverse areas, from drug development to genetically modified agricultural products like Monsanto (NYSE: MON  ) produces. Companies such as Affymetrix (Nasdaq: AFFX  ) also market products like DNA microarrays, which analyze genetic information that can then help researchers to develop drugs or study a disease.

Cash burn: Often, during a drug company's earnings press release or conference call, you'll hear about its "cash burn" or burn rate. This is the rate at which a money-losing drug developer uses up the cash on its balance sheet. It's another way of saying "negative free cash flow." You can calculate cash burn by subtracting capital expenditures from operating cash flow on a company's cash flow statement.

For example, tiny specialty pharmaceutical developer AtheroGenics (Nasdaq: AGIX  ) started 2006 with $183 million on hand. By the end of its fiscal fourth quarter, the company had $152 million in cash and investments on its balance sheet, making its burn rate $31 million for the year.

Until a drug company becomes profitable, it must either take on debt or engage in dilutive financings to support its development activities, once the cash on its balance sheet runs low. It's also worth noting that a company's net loss does not equal its cash burn, since non-cash charges and other items are included on the income statement.

Development-stage: Many analysts refer to certain pharmaceutical companies as development-stage. This means that they have no current drugs approved by the FDA (or elsewhere) for sale on the market.

Drug pipeline: A drug pipeline consists of all the compounds in clinical and preclinical testing for a pharmaceutical firm. When investors are researching drug stocks, this is where they should focus much of their attention. From this pipeline, a company will (hopefully) develop future billion-dollar blockbuster products.

For development-stage and smaller drug companies, you can usually see a complete list of their pipeline on their home page, often under the headings "R&D" or "products in development." For example, here is Rule Breakers pick Millennium Pharmaceuticals' (Nasdaq: MLNM  ) pipeline. As you can see, the company currently has seven different compounds in various stages of clinical development, with some in testing for multiple indications.

Generic drug: Once a branded drug's patents and marketing exclusivity have been exhausted, other companies are free to market their own copies of the drug, as long as they can prove that the copy they sell is identical (or nearly identical) to the branded product. These copies are called generic drugs, and they must still undergo some degree of testing in the laboratory, and be formally approved for marketing by the Food and Drug Administration.

Just getting started in biotech? Looking for some great stock tips of companies using this technology? Come take a free 30-day trial offer to our genetically modifiedRule Breakers newsletter, where you'll find recommendations on these and other companies on the cutting edge of revolutionary technology.

Fool contributor Brian Lawler does not own shares of any company mentioned in this article. Affymetrix and Millennium Pharmaceuticals are Rule Breakers selections. The Fool has a disclosure policy.


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