Investing in biotech is not for the faint of heart, but knowing how to pick probable winners and avoid lemons can make the balance of risks and rewards look a lot more palatable.
But contrary to popular belief, you don't need any deep expertise in biomedical fields to do well in biotech, though it does help. In fact, having a playbook of clever tricks is a big part of succeeding.
Let's learn about three such tricks that I use every day to evaluate biopharma investments.
Image source: Getty Images.
1. Find the big collaborations
Teamwork makes the dream work, and that's why most biotech players are eager to forge collaborations with other biopharma businesses, especially larger ones in big pharma. Collaborations enable patrons to invest in risky yet potentially high-impact programs without the overhead of doing all of the grunt work themselves, and they also allow for smaller competitors to get some financial breathing room as well as access to their benefactor's typically substantial technical know-how. The clever trick is to find the companies that have the strongest and most committed partners.
For instance, CRISPR Therapeutics (CRSP 0.34%) has a massive partnership with Vertex Pharmaceuticals (VRTX -0.06%). That pairing originated in 2015, with Vertex making an equity investment of $30 million as well as $75 million in cash in exchange for the exclusive rights to license up to six medicines produced by the arrangement. But that was just the start.
Other collaborations between the pair followed, and in 2021 Vertex paid CRISPR $900 million upfront within the context of another drug development deal. And soon the program they collaborated on for that 2021 deal, CTX001, could be commercialized as a potentially curative treatment for two different indications -- one for sickle cell disease, and one for beta thalassemia.
Without Vertex's help, it's unlikely that CRISPR Therapeutics would have a shot at commercializing anything at all. But not all collaborations are so make or break; others can simply be a tailwind. As another example, Recursion Pharmaceuticals (RXRX 3.57%) just announced a new drug discovery collaboration with Nvidia worth a $50 million equity investment. The pair will work on their respective artificial intelligence-enabled drug discovery platforms, each using the other's technology to improve their own. That could be critical for Recursion -- or perhaps just good for generating positive press.
2. Check management's record, especially with clinical trial data
Any kind of attempted deception of investors should be a disqualifier with any type of stock, and biotech is no exception. But there's a close-to-zero chance that a biopharma management team would play games with financial metrics to make a company's performance look better than it actually is. Instead, creative interpretation of clinical trial results is the preferred tactic, and it's one that you need to look out for.
Under normal conditions, when a company reports its clinical trial results, it offers a press release that's at least vaguely interpretable to laypeople (like shareholders), while also publishing its full data set and in-depth analysis in a peer-reviewed and reputable scientific journal. Clear statements regarding whether the trial met its endpoints or not are fairly common. Problems tend to occur when a trial fails to meet some or all of its endpoints, yet management's communications obscure or downplay that fact.
The clever trick to learn here is very simple: Just compare management's tone and word choice to a clinical trial's actual results, especially when the results aren't what the company was hoping for. Clear, unambiguous, and up-front reporting of whiffed clinical trial goals is a positive sign for a company's quality, not a negative one. On the other hand, creating spin about "promising" data in the context of a partially or fully failed trial is a big red flag. Winning biotechs accept disappointing results, adjust their plans, and either move on to another target or regroup for a fresh attempt at the same one. Subpar biotechs try to rebrand their stumbles as glimmers of gold that just so happened to be a mere inch beyond their reach.
3. Calculate the cash runway
Winning biotech stocks are those that have enough money in the bank to advance their research and development (R&D) priorities until they're complete, which is roughly when they start to yield revenue. For early-stage companies, this often means having the cash to fund the remaining clinical trials for the lead candidate so that it can be commercialized. If you invest in a business that doesn't have enough cash on hand to accomplish its near-term goals, you're at a high risk of getting your shares diluted, or even losing your entire investment.
So one great trick for investing in biotech is to calculate the cash runway of your prospects. Sometimes management will inform shareholders about how much time their cash can buy, but it's helpful to double-check their math and their assumptions to get the best level of diligence. Let's use Caribou Biosciences (CRBU -1.33%) as an example, as it's an early-stage and pre-revenue biotech with a strong balance sheet.
Caribou's trailing 12-month (TTM) total expenses are $120 million. Looking at that figure tells us very roughly how much it will need on hand to be operating at its current tempo 12 months from now. In the most recent quarter, it reported $292 million in cash, equivalents, and short-term investments. If we divide the cash by the expenses, we get 2.4 years. At that point, it will either need to raise more money by issuing stock or taking out new debt, assuming it doesn't get any additional cash infusions from forging new collaborations or hitting any cash-bearing collaboration milestones it might have.
The other critical factor is that Caribou's lead program, which is currently in phase 1, should be done with its clinical trial two years from now. It has enough money to accomplish that near-term goal. And if its phase 1 results are strong, it can probably find a collaborator for phase 2 and beyond, so it might not need to raise more money.
Longer cash runways are better. But don't forget that very few of a biotech's expenses are truly fixed. And remember: Having more time to advance clinical trials does not guarantee that those trials will succeed. But with enough money, companies might be able to rework their programs or pivot if they aren't getting the results they need to advance to the market, so always keep an eye on the plumpness of their wallet.
