Biotech stocks offer the opportunity for enormous one-day gains after biotech companies experience positive clinical trial data or regulatory approvals. But the upside from the binary events may not justify the risk investors are taking. In this video from Motley Fool Live, recorded on Jan. 4, Corinne Cardina, bureau chief of healthcare and cannabis, and Fool.com contributor Brian Orelli discuss the pros and cons of investing before binary events.
Corinne Cardina: If you look at the stocks we've talked about with these looming FDA decisions, are any of them a buy ahead of their respective dates or which ones could become buys if the decision is ultimately positive?
Brian Orelli: I think it's really hard to play the binary event game. You basically need to be smarter than other investors. Sometimes, you can find inefficiencies, but I tend to see more inefficiencies where I feel like investors are overly excited than overly pessimistic. Of course, when they're overly excited, you can short the stock, and if you're right, and the event is negative, then you'll make a lot of money, but you're exposing yourself to a lot of upside if the event ends up being positive. I've never done that and I don't think I probably would be able to find something where I felt confident enough that people were overly optimistic enough that they would actually do it.
I think Biogen (BIIB 3.40%) is probably a really good example here. I think it's really hard to handicap what the FDA is going to do. It's trading about where the FDA advisory committee -- where it was before the FDA advisory committee, so the investors aren't being overly optimistic. But there's still some upside priced in, and I think it will drop if the Alzheimer's disease drug isn't approved.
In terms of buying after approval, you really have to look at valuations. Sometimes especially with smaller companies, you'll see investors get overly excited about the drug launches, and then that will increase the valuation where the risk-reward, it doesn't look as good as it would if they weren't overly excited about the launches. The valuations just get too high, and then the upside -- potential for the peak sales isn't as great.
Cardina: Right, so probably better to play the long game here rather than try to beat them, beat other investors before an FDA decision or jump on as soon as it's green light. You want to make sure that they can actually get the drug on the market and that it works well.
Orelli: Yeah, exactly.