3 Stocks to Play Biotech

Biotech. The sports cars of the investing world, where fortunes can be made or lost, literally overnight. These stocks, probably more than any other, rely on binary events that can send a stock soaring or plunging.

Source: Company press releases.

Just so you know, a failed trial doesn't always mean a destroyed company. Medivation is continuing to explore Dimebon for mild-to-moderate Alzheimer's and Huntington disease. And GenVec is moving forward with its other pipeline programs, which focus on vaccines and hearing loss. On the other hand, Human Genome Sciences has submitted marketing approval applications in the U.S., Canada, and Europe for Benlysta.

While we all hope to grab big winners like Human Genome Sciences, investors in biotech must be aware of the chance of ending up with one of the big losers. The landscape is littered with once-promising drugs that either didn't make it out of clinical trials or were turned down by the Food and Drug Administration.

The keys to success
The important things to understand and follow when investing in biotech are:

• Number of drugs in the pipeline and position in the pathway to approval. A successful phase 1 study is not nearly as big a deal as passing phase 2 and entering phase 3. Getting in after a lead candidate begins phase 3 is the sweet spot, because if it succeeds, the stock price would likely jump and then could jump again when (I mean "if") the FDA approves it.
• Presence of marketing or development partnerships with big pharma. Marketing might is needed to successfully sell the drug, and big pharma's deeper pockets can certainly help a struggling biotech while developing a promising drug. Plus, the scientists from big pharma have vetted the potential drug, giving a measure of safety to investors. But even they can be caught by surprise (witness Medivation, which had partnered with Pfizer), so this is no guarantee.
• A basic understanding of some clinical trial and statistical terms. Double-blind, randomized trials are best, especially in phase 3. Patients have been randomly assigned to receive placebo (or an alternative drug) or the drug under investigation, and neither the patients nor the doctors know who is getting what (that's the "blind" part), and neither does the company. This means that trial results should come from just the action of the drug and not be "massaged" by researchers. Showing that a drug is "non-inferior" means it's "at least as good as," but for judging potential sales, "superior" can be better. Finally, to be successful, the results have to be "statistically significant." That is, the probability that the results are due to chance has to be really small. Smaller is better, so a "p ≤ 0.005" (0.5% probability that the result is a fluke) is better than "p ≤ 0.01" (1% probability that the result is a fluke).

Three ideas
With that introduction over, here are three companies to consider:

Source: Company websites, releases.

Keryx is waiting on phase 3 data for its lead drug candidate perifosine for treating colorectal cancer and multiple myeloma. The FDA recently granted the drug a fast-track designation. Keryx also has a phase 3 trial which it recently started for Zerenex to treat a side effect of kidney dialysis. Its strong balance sheet and low cash burn rate -- it expects to spend $18 million this year -- has management saying it should be able to see these through to the end without having to sign away the store to a marketing partner to raise money.

MannKind was turned down last March the first time it submitted Afrezza, its inhalable insulin product, to the FDA. Just last week it announced that it had answered the FDA's concerns and resubmitted its application, which had been accepted. Fast work! The company and investors should hear back from the FDA by the end of the year. Plus, the news is good for negotiating partnerships to sell Afrezza, should it be approved.

Later this year, Immunomedics will begin a phase 3 study with Belgian partner UCB to study epratuzumab for treating lupus. It's also designing a phase 3 study for using the drug against aggressive lymphoma. Of the three, this company is the furthest from market and, if epratuzumab works against lupus, it would have to compete against Human Genome Sciences' Benlysta, assuming they're both approved.

Final thoughts
The medical science that biotech companies are involved in scares away many investors. But a science background isn't really required to invest successfully here. Instead, an appreciation for the binary events, the partnerships, and the size of the pipeline that can be turned into revenue will go a long ways toward putting you onto the road to success. The above companies are three likely candidates that may help get you there.

So do some reading, review the articles linked above, and come back to Fool.com, where we regularly cover biotech.

And if you want more, you could also take a free 30-day trial to Motley Fool Rule Breakers, where biotechs are often chosen, including recent winner Momenta Pharmaceuticals.