Investing in biotech companies isn't without its challenges, but it doesn't have to be a shot in the dark, either. With a little bit of study, investors can have profitable trades using a couple of successful investment strategies.
Investment strategy #1: Buy the run up.
On the surface, it's a simple investment strategy. As a binary event approaches, the price tends to increase as short-term traders glom onto a stock because they're unwilling to own shares months or even weeks ahead of Food and Drug Administration decisions or clinical trial results.
Investors with a little longer time frame can buy well ahead of the event, enjoy the run up, and then sell shares before the binary event.
It's not a risk-free investment strategy, though. Not every biotech runs up ahead of its binary event; you're counting on the actions of other investors, and sometimes they don't show up. Technically, all investment strategies count on finding investors who are willing to pay more for a stock than you paid, but it can be dangerous over a short time frame with looming binary events.
The other downside of this investment strategy is that it's not always clear when a decision will happen. Recently, the FDA has been making decisions well ahead of the goal set by the Pharmaceutical Drug User Fee Act, commonly referred to as the PDUFA date. ARIAD Pharmaceuticals (NASDAQ:ARIA), for instance, gained early approval for its leukemia drug Iclusig last year, and shares traded down by double digits after the widely expected announcement.
Investment strategy #2: Short the launch.
FDA approvals are exciting -- sometimes too exciting. Investors are so thrilled that a biotech finally has revenue that they forget that drug launches are difficult.
Observe the peaks in July 2012 after the FDA approved VIVUS' (NASDAQ:VVUS) and Arena Pharmaceuticals' (NASDAQ:ARNA) obesity drugs. VIVUS launched Qsymia a few months later to lackluster sales. Arena's Belviq was just launched earlier this month after waiting for the DEA to sign off on the drug's scheduling. While Arena sits a little lower than its post-approval high, it still has a ways to fall if the drug also fails to meet investors' expectations.
Of course, shorting every FDA approval won't work and could be very costly. Check out Regeneron Pharmaceuticals (NASDAQ:REGN) after the November 2011 approval of its macular degeneration drug, Eylea. Once prescription and sales data started rolling in -- smashing investors' expectations -- shares zoomed higher.
Investment strategy #3: Long-term buy and hold.
An oldie but a goodie. Find a good biotech that can develop multiple drugs and hold for years.
It's certainly harder than it sounds, but can be very profitable if you can find the next Celgene (NASDAQ:CELG). A 14-bagger over 10 years? Most investors would gladly take that kind of return even if it's only a small portion of their portfolio.
Beyond the difficulty of finding a company that can produce the sales that Celgene's drugs have, it can be difficult to stick with the company for that long. Celgene was arguably overvalued at times over the last 10 years. Selling at the highs and buying at the lows would produce an even higher return, but identifying the peaks and valleys is difficult.
Fool contributor Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Celgene. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.