Source: Celgene.
Imagine a parallel universe where the laws of physics work in strange ways. Perhaps gravity sometimes works in reverse, or light travels more slowly than sound. Investing in biotech industry stocks can often seem just as odd and counterintuitive.
Buying biotech stocks frequently involves quite a different way of thinking from investing in other industries. With that in mind, here are three stock market tips for investing in the biotech industry.
1. Know which financial metrics really matter.
Metrics such as the price-to-earnings ratio and return on equity are usually important when buying stocks. That's not necessarily the case with biotech stocks, though -- especially for development-stage companies.
Celldex Therapeutics (CLDX 0.85%), for example, has consistently lost money, and therefore has no P/E ratio or other earnings-based financial metrics to evaluate. There is an important financial figure investors should watch carefully with Celldex and other biotechs with no product yet on the market: available cash. This number should be used in conjunction with the company's cash burn rate to determine how quickly additional funds will be needed.
Development-stage biotechs typically sell more shares to generate more cash. That's the route Celldex took in February, and several other times in the past. The good news is that biotechs can bring in money to fund continued development with this approach. The bad news is that these secondary public offerings dilute shares and usually cause the stock to drop.
Traditional financial metrics can be used in assessing the stocks of more mature biotech companies, though. Celgene (CELG) is one biotech with multiple products on the market that made nearly $2 billion in earnings last year. Comparing Celgene's price as a multiple of both trailing earnings and forward earnings estimates against other big biotechs can be useful in valuing the company.
2. Pay close attention to every clinical update.
Biotech companies' future fortunes depend on their drug pipelines. That's especially true for up-and-comers like Celldex, but it also applies to established companies like Celgene. Investors looking to potentially buy the stock of a given biotech definitely will want to closely monitor clinical updates on key drugs in the company's pipeline.
Source: Celldex Therapeutics.
As a case in point, Celldex announced interim results in November from a mid-stage clinical trial of its drug Rintega combined with Avastin. The cancer drug combo appeared to perform very well, with a statistically significant survival benefit. That good news kicked off a nice jump in Celldex's share prices.
Clinical updates provide biotech investors insight into the effectiveness and safety of pipeline drugs. Better-than-expected results can often serve as catalysts for sustained upward momentum for the stock. Also, the market can overreact sometimes to slightly disappointing clinical results, presenting an opportunity to buy a promising stock at a more attractive price.
3. Understand the FDA approval process.
Clinical updates are helpful, but the fate of any drug ultimately comes down to regulatory approval -- or lack thereof. In the U.S., the Food and Drug Administration holds the power to make or break a drug candidate.
We won't cover the full FDA approval process (click here if you want a quick overview), but the key things to understand are that there are usually three stages of development. Generally, biotechs submit for approval after the completion of the third stage. From there, FDA decisions can make shares soar into the stratosphere -- or sink into the abyss.
The regulatory process must be repeated for each indication a drug targets. Celgene's blockbuster drug Revlimid, for example, has been on the market for a while as a treatment for several indications, including relapsed/refractory multiple myeloma. However, the drug still awaits completion of clinical testing for other indications, such as chronic lymphocytic leukemia, before it can be considered for regulatory approval.
Of mind-sets and money
While buying biotech stocks might require a different mind-set than investing in other industries, it can be well worth your while. Major biotech exchange-traded funds have more than tripled the performance of the S&P 500 over the last five years.
Companies like Celgene and Celldex could keep that trend going. Celgene's arsenal includes powerhouse Revlimid, potential blockbusters like Abraxane, and promising drugs in the pipeline. Celldex's Rintega should be a big winner in the not-too-distant future -- and it just might spur acquisition interest from bigger players.
There are plenty of other biotech stocks investors could love. Just remember to think differently.
