Investing in biotech can sometimes feel like a roller-coaster ride. It's fairly common to see your shares soar by 30% or more in one day after a company reports positive clinical-trial results, only to see them plummet the next day. Of course, there's no guarantee that you'll get the joy of seeing a sharp uptick in advance of a steep drop, which complicates matters further.
There's no way to predict the future, but by paying attention to two key pieces of information, you can guard yourself from at least one cause of brutal losses. Here's what you need to know and what you need to do.
It takes a lot of gas to reach key catalysts
As you probably know, it takes a lot of money for biotechs to do research and development (R&D) activities that eventually have a chance of yielding medicines or technologies which can be sold for revenue. Early-stage businesses won't have any inflows of cash as they don't have a product that's approved to sell. Therefore, the first thing you need to pay attention to in order to avoid big losses is how much cash your holdings or prospects have on hand.
But simply having some cash isn't quite enough; what you actually need to know is if a company has enough cash relative to its planned expenditures. Management frequently communicates how long it expect the money on hand to last. It's also easy to calculate a rough estimate by simply dividing a biotech's cash, equivalents, and short-term investments by its trailing-12-month operational expenses.
Sometimes, when a business is approaching the end of its cash runway, the timing is such that it won't have a problem financing its next set of activities. When a biotech is about to launch its first drug, even if it's low on dosh (a British term for money), it typically won't be difficult to take out a loan to pay for the costs of commercialization, after which it could become profitable.
More frequently, however, companies that don't have a product ready to sell end up needing to issue more stock to raise funds before they run out of runway. And that leaves existing shareholders with steep losses.
Understanding the cash runway
The good news is that it's fairly easy to figure out when a biotech might need or prefer to do a stock offering. Clinical trials cost progressively more money with each advancing phase. As phase 1 trials are typically small and tightly confined in scope, they're the cheapest. Per a report by Eastern Research Group commissioned by the U.S. Department of Health and Human Services (HHS), phase 1 studies cost an average of $4 million.
In contrast, late-stage trials require larger cohorts and significantly more overhead too. Phase 2 trials will set a biotech back an average of $13 million a piece, whereas phase 3 investigations run for an average of $20 million, though some can be far more expensive.
Companies are loath to initiate trials that they don't have the funds to complete. After a trial concludes, if its results are favorable, share prices tend to rise, sometimes by a lot. That's why many biotechs decide to issue new stock immediately after or sometimes even contemporaneously with reporting their mid-stage or late-stage results. They need the money for the next leg of the journey, and their stock price is as good as it'll likely get until more data comes out.
Take Editas Medicine (EDIT +4.03%) as an example. On June 9, it reported positive phase 1/2 data from one of its programs for sickle cell disease, then on June 14 it announced a stock offering worth $125 million. In the first quarter, it had cash and equivalents which management said were sufficient to take it into 2025, so the offering was designed to take advantage of the boost its shares got from the data release.
NASDAQ: EDIT
Key Data Points
But Editas is far from being the only example among biotech stocks. Caribou Biosciences followed the exact same pattern this July, reporting great early-stage results and then immediately using the boost in their stock to sell more shares at an attractive price, thereby granting it enough cash to survive until at least the next set of clinical milestones.
Remember, if a company has less than two years' worth of cash on hand, it's reasonable to expect management to be on the prowl for similar fundraising opportunities whenever they arise, and the pressure of needing to do late-stage trials means that costs tend to escalate and compress the runway.
Therefore, if you pay attention to both a biotech's cash holdings as well as its schedule for concluding and initiating clinical trials, especially late-stage ones, you'll have a roadmap for when it might need to raise money by issuing shares. At that point, you can choose to wait to buy in or bulk up your position until after the offering, potentially picking up shares at a discount.
If you're vigilant in this way, you'll also inoculate yourself against the risk of the trial missing its endpoints, which tends to send share prices spiraling downward. Of course, the risk is that you'll miss out on the stock shooting upwards, but that's the cost of investing more safely, and for some investors that cost might be worthwhile.
