Investing in biotech stocks is a tricky and risky endeavor, but there's a lot investors can do to increase their chances of success -- or at least avoid total failure and the loss of their funds.
Here are three quick tricks that'll help to guide your biotech investments. You'll find them to be the most useful when you're evaluating whether to buy shares of a given company, but they'll also help you to understand when one of your holdings is entering a risky period.
NASDAQ: BLUE
Key Data Points
1. Cash comes first
Many of the biggest opportunities in biotech stem from companies that haven't generated any revenue from sales of a medicine yet. With no income, those early stage businesses are usually in a race against time to commercialize a product before their money runs out and they have to shut down.
With research and development (R&D) expenses being necessary for them to have any hope of a future, the bigger the R&D budget, the more money they need to keep on hand. That's especially true, considering biotechs may opt to raise funds by issuing new stock, thereby diluting the value of their shares, not to mention the inherent difficulty of using debt financing in advance of having any means of repaying loans.
But how much cash is enough? A good rule of thumb is to look for businesses that have at least two years of cash relative to their trailing-12-month operating expenses. Take a look at this table depicting the cash holdings and expenses of a small group of biotechs:
|
Company |
Trailing 12-month operating expenses |
Cash, equivalents, and short-term investments as of the most recent quarterly report |
Probability of needing to raise capital within the next 24 months |
|---|---|---|---|
|
Compass Pathways |
$117 million |
$248 million |
Low |
|
Verve Therapeutics |
$224 million |
$485 million |
Low |
|
Bluebird Bio |
$227 million |
$174 million |
Very high |
|
Editas Medicine |
$233 million |
$350 million |
Medium |
Source: YCharts.
If you had invested in Bluebird Bio (BLUE +0.00%) right after seeing its cash holdings as reported in its latest quarterly results in early November, it would mean taking on a significant risk of your shares getting diluted by new stock issuance. In fact, on December 19, the company announced that it would be issuing new shares to the tune of $125 million, causing its stock to crash.
You might still get diluted with the other companies eventually, but at least they have a bit more runway to work on their pipeline programs without financial pressure.
2. Look for hints from regulators
When regulators weigh in on whether a company can proceed with its next phase of clinical trials or whether a company is allowed to commercialize one of its mature candidates, there's always an element of uncertainty. It's simply not possible to perfectly predict how they'll interpret a biotech's data, especially considering they are privy to a significant amount of information that investors aren't. But a lot of the time, you don't need to go into an investment blind, because regulators and management teams drop hints as to what they're thinking.
Take the recent case of CRISPR Therapeutics (CRSP 4.83%) and Vertex Pharmaceuticals getting their jointly developed gene therapy for sickle cell disease (SCD) approved by the Food and Drug Administration (FDA). In advance of the approval, an advisory committee of outside experts met and considered the materials submitted by the pair. That committee published briefing notes online describing the nature of their inquiries ahead of time, and the meeting minutes were also published afterward.
Per the minutes, the panel members commented that none of the issues they discussed led them to be skeptical of the candidate's performance in treating the disease.
NASDAQ: CRSP
Key Data Points
It's true that in this particular case, the members of the advisory committee were not the same people as the ones responsible for the final yes-or-no vote on whether to allow the two companies to commercialize their therapy. Still, it's highly valuable to get a peek into the regulatory mindset, especially if they appear to be concerned about certain points of ambiguity in clinical trial data or major safety problems.
If you discern that regulators aren't fully comfortable with what biotechs are presenting to them, it's a sign that there could be major losses waiting in the wings for shareholders. There's hardly anything more immediately destructive to a biotech stock's share price than an unanticipated setback imposed by the FDA.
3. Don't count your eggs before they hatch
The final money-saving trick with biotech stocks is to take a far more conservative perspective than what management or even Wall Street analysts suggest.
Despite ebullient-sounding press releases and optimistic public comments by senior leaders, clinical trials fail all the time. Don't be fooled. Until a pipeline candidate gets the stamp of approval to be used to treat members of the public, its future value is far closer to zero than any estimates about how much revenue it might bring in per year. Furthermore, instances of companies being able to license their failed candidates to other businesses to recoup some of the R&D costs are uncommon, and licensing deals should not be counted on as a fall-back plan.
Attaining special regulatory designations is also not something to take for granted. Even if management makes a good case to investors for why a certain candidate deserves to pick up a Fast Track classification or a similar allowance, regulators have the final call, and they don't take a company's desires into consideration when making their decisions. The same goes for the less common fruits of success with the regulatory process, like Priority Review Vouchers (PRVs).
Recently, Bluebird Bio communicated to its investors that it anticipated picking up a PRV at the same time as the approval for its gene therapy for sickle cell disease. It inked a deal with Novartis to buy the PRV for $103 million. But on Dec. 8, when its therapy was approved, the biotech didn't actually get the PRV from the FDA as anticipated, tanking its stock price and precipitating a worsening of its cash crunch. It ultimately had to solve that crunch by issuing more stock, thereby diluting its investors.
To avoid that outcome with your investments, be extra skeptical of investing based on hypothetical situations.
