Since its initial public offering in late 2019, the German coronavirus vaccine developer BioNTech (BNTX -0.45%) has grown more than 2,150%, making its early investors quite rich. While many might scoff at the prospect of discovering such a lucrative investment in the absence of a key event like a global pandemic, I'm of the opinion that it's entirely possible.
There's no single secret to picking winners in biotech, but there are a few things that vastly improve the odds. Let's examine three tricks that you can use to screen for millionaire-makers like BioNTech, so that you'll be ready to invest when you see one.
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1. Check out the total addressable market and the competition for it
Biotechs need to capture a significant share of a potential market to succeed. So, when you're hunting for millionaire-maker biotechs, it helps to identify a specific market segment to guide your search. And, that segment needs to be large enough to make taking a share of it worth doing. In the case of BioNTech, the market would be for mRNA medicines.
For investors, this means two things.
First, "large enough" may be much smaller than one might suspect. If a biotech's drug could treat 100% of the patients in a market worth $1 billion each year, and there's nothing else that those patients can take to address their symptoms, the stock might have big-money potential.
While $1 billion is on the small side for a total addressable market, the simple fact is that people with currently untreatable illnesses still want to get better. And if the company successfully commercializes its drug, those people will flock to get treated, and no competitor will be able to touch the revenue for quite some time. Early investors will get rich.
The second thing is that trying to capture a significant share of a heavily contested market is often a losing strategy for a biotech developing a new therapy.
Competition drives margins lower, and the bar for stealing revenue from competitors is often high. Still, if demand for a medicine is hot enough, as with BioNTech's coronavirus vaccine, the likely presence of future competitors can be strong evidence in favor of a stock being a potential millionaire-maker. Unexploited markets that appear to be highly lucrative tend to attract a crowd. It's when those competitors become entrenched that new entrants can struggle.
2. Understand the business model and its risks
Once you've identified a biotech market where millionaire-making companies might exist, it's time to pay attention to the business models of the companies competing there.
Most biotechs rely on their research and development (R&D) teams to produce new drugs or technologies. Then those projects go through the rigors of the clinical trials process, and, if everything goes well, eventually get regulatory approval for sale. Once the products are commercialized, the company usually has a period of exclusivity in which competitors can't eat their lunch by copying them. This is exactly how BioNTech does things.
That business model is quite risky by design, as it relies on successes in the laboratory to be exceeded by later successes with real patients in the clinic, and all in a way that will be convincing and comprehensible to regulatory authorities. But it's the industry's norm, and investors should understand that deviations from it introduce additional risks -- and potentially, rewards.
Some aspiring drugmakers end up adding to this core model to generate small amounts of revenue, typically by providing research or manufacturing services of some kind to a larger biopharma. However, this revenue is rarely sufficient to make a profit. And it may not even lead to any new know-how or organizational competencies. In some cases, providing services ends up becoming a poor substitute for having a robust pipeline of clinical programs.
So, while it may seem like a good idea to invest in a small biotech with no product in the works but a lot of customers in the industry, think twice. There might not be any chance of making millions if there aren't any drug development catalysts to look forward to.
3. Find companies that haven't been discovered yet
To narrow down your preliminary picks, it's helpful to identify smaller companies that haven't yet had their 15 minutes of fame despite competing in a promising market.
For example, BioNTech was hardly a household name before its coronavirus vaccine collaboration with Pfizer began in early 2020, but at least a few investors recognized the company's merits and the future vibrancy of the mRNA space.
Finding undiscovered gems generally means looking at unprofitable operations that don't yet have any recurring revenue or any products on the market. Often, these businesses will be small caps or micro caps (a micro cap has a market capitalization of $300 million or less), so that's a good metric to start your search.
The advantage of this strategy is that it ensures you'll be exposed to the impact of quite a few critical catalysts over time; one example is when a small biotech moves a program from an early stage of the clinical trials process into a later stage.
There's no guarantee that all of these catalysts will be positive, as drug trials frequently fail. But if you diversify your biotech investments into several different pre-product businesses, there's a healthy chance that the growth of the survivors will far outweigh the losses. And, by investing before a stock is discovered, you'll usually be able to buy it while the price per share is still quite low. So when the market finally does notice, as it did when BioNTech produced its coronavirus vaccine, you'll get a large return:
Data by YCharts.
When you're assembling your biotech portfolio, keep in mind that only about 14% of drug candidates survive the clinical trials process to reach regulatory approval and commercialization. That means if you're investing in companies with early stage projects, you'll probably need to have at least seven or eight prospects in your portfolio if you want close to a 100% chance of one of them eventually succeeding, assuming they each have one program.
