As you may have heard amid the recent hype surrounding artificial intelligence (AI), Schrödinger (SDGR 2.70%) is one of the leading biotech companies using machine learning and AI to discover new drugs, and it might be the only one with a claim to being profitable in this pursuit. It's undeniable that investors are interested thanks to its position in a cutting-edge field -- and the stock is up 50% so far this year.
But does that mean you should add it to your portfolio in the hopes of capturing significant growth as it matures? Let's investigate how it's actually performing, as well as how it's likely to shape up over the coming years.
Don't get too attached to its profitability
Before you buy shares of Schrödinger, it's important to recognize that its top- and bottom-line growth are far from assured in the near-term.
The company's approach is to discover new candidates for further development using both artificial intelligence and adjacent techniques like machine learning, as well as simulation-based modeling of physical interactions between biological targets and potentially therapeutic molecules. It plans to sell licenses of its drug discovery and development software, and to collaborate directly with biotechs attempting to find favorable candidates to advance into preclinical testing.
Those activities are how Schrödinger had a net income of more than $4 million in Q2, marking its second profitable quarter in a row. In the past, it helped Agios Pharmaceuticals bring two candidates to market, and it's currently working with Structure Therapeutics on two early-stage clinical programs.
But its second-quarter revenue of $35 million was 8.5% lower than it was a year prior. Both its software license sales as well as its collaboration income are down. Without the company revealing a capability that would be a major new draw for other biotechs, it's hard to see how its software segment might pick up. And given that its collaboration revenue is linked to the milestones it attains, it could take quite some time before it reports growth again. Even then, the growth from collaborations is unlikely to be recurring in nature.
It's also developing medicines on its own, which is how it might one day bring in recurring sales. At the moment, it has a phase 1 trial in progress to see if its candidate can treat relapsed or treatment-resistant non-Hodgkin's lymphoma. It could also soon advance a program for treating hematological cancers and solid tumors into the clinic. Still, it'll be years before it has a chance to ask regulators for permission to commercialize its programs, and there could be failures along the way.
Risky, but moving in the right direction
There's a solid chance that Schrödinger's shareholders will have a bumpy ride over the next few years. The competition is rapidly mounting, its profitability is tenuous, its medicines are years from being approved for sale -- assuming they ever are -- and its revenue is unlikely to be very steady in the interim.
Customers haven't yet flocked to use its software, nor does management seem to have a plan to change that aside from continuing to develop the platform. Its valuation, with a price-to-sales (P/S) multiple of 11.5, is fairly high despite its limited growth thus far. What's more, it lacks powerful collaborators who could help out in a pinch. All of these factors make it a risky purchase in the near-term, much like any other early-stage biotech stock.
In the long term, however, the picture is very different. AI-driven drug discovery is not going to go away anytime soon, even if it takes time for its core promise of research and development (R&D) cost cutting to be proven. It isn't a fad so much as an acceleration of the previous trend of data-driven discovery, and that trend ultimately yielded a plethora of physiological targets, molecular leads, therapy candidates, and eventually commercialized precision medicines.
Whether it's Schrödinger or one of its competitors like Recursion Pharmaceuticals or 23andMe, at least one player is going to make a bundle from being the go-to collaborator for the biopharma sector on this front.
So making a bet on Schrödinger is smart in the sense that it has a credible chance of being one of the future's big winners. If you accept that it might be a long and turbulent journey from now until the identities of those future victors become clear, it's worth buying. Just remember that there's nothing stopping you from buying shares of its competitors, too, as doing so would maximize your chances of getting a good return from the AI revolution ongoing in biotech.
