Plenty of growth investors flock to biotech stocks because the industry can provide eye-popping gains. For example, shares of Tesaro (NASDAQ:TSRO) more than doubled after the company posted positive data from a clinical trial earlier this year. Unfortunately, trial results just as often lead to lightning-fast losses. In September, Novavax (NASDAQ:NVAX) shareholders lost 84.5% overnight when the company announced a clinical upset.
However, just because biotech stocks can be volatile doesn't mean careful investors should avoid them entirely. Here are two lessons from Novavax's failure and Tesaro's success that can help investors of all stripes make better decisions.
1. Understand basic statistics before buying biotech stocks
Most people I know are intimidated by the thought of digging through statistics, and the rest would prefer to watch paint dry. Luckily, understanding just one measurement can help you make better decisions.
One of the most useful figures is the p-value. In a nutshell, it tells you how likely it is that a difference observed between two test groups owes to random chance.
Not so long ago, Novavax separated 1,600 test subjects over 60 years old into two groups. It dosed one group with its experimental respiratory syncytial virus (RSV) vaccine, while the other group received a placebo. After a year, 39 members of the placebo group showed RSV symptoms versus 23 in the group that received the vaccine candidate. This worked out to a p-value of 0.041, which essentially means there was a 4.1% chance the lower infection rate was caused by random chance.
Generally, p-values below 0.05 are considered significant, but they do not measure the chance of success in larger studies. I don't have enough fingers to count the number of non-Foolish articles and comments I saw that misinterpreted the observed p-value of 0.041 as a 95.9% chance that the subsequent 11,850-patient trial would succeed. Biotech investors frequently misinterpret the p-value in this way, which can get them in trouble.
Novavax shareholders learned this lesson the hard way when a slightly higher percentage of patients receiving the vaccine became infected with RSV than those injected with a placebo. The stock tanked, and because Novavax doesn't have another candidate ready for a study that could support a New Drug Application (NDA), I wouldn't be surprised it it falls even further.
2. Know how to respond to response rates
Without a doubt, biotech investors want to focus on next-generation cancer therapies. Unfortunately, it's not unusual for such candidates to move from successful studies that lack control groups -- and in turn p-values -- straight into controlled trials designed to support NDAs.
Long-time Tesaro shareholders will happily tell you that careful consideration of observed response rates in uncontrolled trials can lead to huge gains. Back in 2013, the company presented data from a tiny early-stage trial with advanced ovarian cancer patients. Of 13 patients receiving between 30 milligrams and 400 milligrams of niraparib each day, six responded to the experimental drug.
On the surface, shrinking tumors among 46% of the group isn't that exciting. If you'd looked a bit closer, though, you would have noticed the majority of women in the trial had previously experienced disease progression after six or more lines of therapy. Also, three of four patients who happened to have tumors sensitive to platinum-based treatment and had received 300 milligrams daily responded to the treatment.
Based on the limited yet positive data in these heavily pre-treated women, Tesaro designed a much larger trial with platinum-sensitive ovarian cancer patients. For this trial to be considered successful, patients receiving 300 milligrams daily needed to survive longer without tumor growth than those receiving a placebo. Since this was the same dose that led to the 75% response in platinum-sensitive patients, and time to disease progression in the smaller trial was surprisingly long, the chance of success looked strong.
As the early response rates suggested, the placebo-controlled late-stage study was a rousing success. Most patients receiving niraparib survived without disease progression more than twice as long as the placebo group did, and the stock shot through the roof. Investors who bought shares on the day Tesaro started the big trial have seen the price of their shares grow about 257% at recent prices, as the results make an approval for this indication seem like a slam dunk.
Tesaro is also testing niraparib in breast cancer patients, and its partner Johnson & Johnson is running a trial with prostate cancer patients. If the candidate is successful in either, the stock could soar higher still.
Before you place all your chips on a risky oncology stock with great response rates, or bet heavily against a biotech based on lackluster p-values, it's important to understand there are no guarantees. These are guidelines, not rules.
Biology can be surprisingly uncooperative, and even well-informed decisions sometimes lead to heavy losses. Applying these two lessons, though, could save you a bundle in the long run.
Cory Renauer owns shares of Johnson and Johnson. You can follow Cory on Twitter @coryrenauer or LinkedIn for more investing insight. The Motley Fool recommends Johnson and Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.