Source: U.S. Food and Drug Administration via Facebook

Bringing a drug to market is truly an arduous process that most consumers take for granted.

According to Medscape, only one in every 5,000 to 10,000 drugs that enter preclinical studies will ever make it onto pharmacy shelves. In context, CNN reports that the odds of having 12 children in a row that are boys is approximately 1-in-4,000. That's right, you're more likely to have 12 male children in a row than have a preclinical compound work its way through the drug development process and be approved by the FDA.

But just understanding the rarity of getting a drug approved is only scratching the surface. As an investor in the healthcare sector you need to be able to understand the drug development process inside and out -- from concept to approval. Having a keen understanding of the drug development process can make you a better investor since you'll recognize how much value should be assigned to positive clinical or preclinical results.

With that being said, let's take a detailed look at the drug development process from start to finish.

Source: U.S. Food and Drug Administration via Facebook

Drug discovery
The first step in the drug development process is to identify a molecule, such as a protein or gene, to target. Drug developers will then test this molecule in a specific disease indication to determine whether or not the target molecule is indeed involved in the disease. If the prospects look promising, then the drug developer will move the drug-hopeful into the next phase of testing.

Realistically, the drug discovery process will involve an astronomically large failure rate, but since this is the earliest stage of development researchers can bounce back from failed molecules pretty quickly.

Sarepta Therapeutics (NASDAQ:SRPT), for instance, is currently developing eight therapies targeted at Duchenne muscular dystrophy, and a handful of infectious disease vaccine hopefuls. One of its more exciting candidates here is Viral PMO-X, a discovery-stage vaccine for Dengue, a mosquito-borne viral infection that affects an estimated 390 million people per year. Though exciting, it's important to note that discovery-stage compounds still have a high propensity to fail. 

Source: U.S. Food and Drug Administration via Facebook

Preclinical testing
The next step in the drug development process is preclinical testing. Typically the preclinical testing process involves anywhere from two to four years of research, and is itself divided into two primary components: in vitro and in vivo testing.

In vitro testing simply means testing the molecule in question in test tubes within a lab. In vivo testing happens after positive results are observed during in vitro testing and involves actually testing the molecule in animal models. While drug developers wouldn't advance a drug if it wasn't demonstrating some encouraging degree of efficacy, the purpose of extensive preclinical studies is to establish a safety profile that would allow a drug developer to move a drug (eventually) into human, or clinical, trials.

Cancer immunotherapy developer Advaxis (NASDAQ:ADXS) has a been a big beneficiary of preclinical data in recent months. Shares soared in April following three presentations at the American Association for Cancer Research's annual meeting, of which two were preclinical. Its preclinical studies involved ADXS-HPV, a drug targeted at human papillomavirus-associated cancers. In one study, which was in combination with an anti-PD-L1 antibody, some degree of tumor suppression was observed compared to the anti-PD-L1 monotherapy arm in mice. In another, ADXS-HPV was combined with anti-OX40 and anti-GITR antibodies, which led to the regression of existing tumors in 40%-60% of animals treated.

But, like the discovery process, there's still a good chance of drug failure at this stage.

Investigational new drug application filing
If a drug developer is able to get its ducks in a row and receives favorable safety data from its years' worth of preclinical studies, the next step in the drug development process is to file for an investigational new drug application, or IND, with the FDA. The IND is more or less a request from the drug developer to begin testing on human patients. It's also the first point at which the FDA will get a closer examination of how the molecule is believed to work, as well as how it's manufactured.

If the IND is approved, the clock on patent exclusivity will begin. Typically, innovative drugs are protected from generic versions for a period of 20 years. On average, close to half of a drug's patent life is spent in clinical studies.

U.S. Food and Drug Administration via Facebook

Phase 1 clinical studies
Once an IND is approved, drug developers move into human testing in phase 1 studies. Phase 1 studies are typically comprised of a small group of people (usually a few dozen), and the molecule will be tested on healthy subjects in many instances. The point of a phase 1 study isn't efficacy, even though we do, on occasion, see biotech stocks rally following efficacy data from phase 1 studies. On the contrary, phase 1 clinical trials are designed to test the safety of a drug and to establish a maximum tolerated dose for a drug. Once again, the chances for a drug to fail are in phase 1 are still incredibly high.

A great example of promising phase 1 data comes from Agios Pharmaceuticals (NASDAQ:AGIO). Earlier this month Agios reported final phase 1 data on its IDH2-mutant inhibitor AG-221, which showed an overall response rate of 40% and durable responses of greater than 15 months in some instances for select blood cancer patients. This data is clearly impressive, but there's still so much more testing to come.

Phase 2 clinical studies
In phase 2 studies the patient pool increases in size to usually around 100 or more patients. More importantly, this is the stage where individuals afflicted with the disease indication become trial participants.

Source: U.S. Food and Drug Administration via Facebook

There are a number of goals in phase 2 studies, although efficacy is still far from the primary goal. Here, drug developers are focused on safety, short-term side effects, and finding the most optimal dose. Reported efficacy is usually just gravy at this point. Though the failure rate from phase 2 studies is still high (around 80%), investors begin to get a decent idea of a drug's safety profile at this point.

Assuming a developing molecule meets its predetermined phase 2 safety expectations and a proper dose is discovered, the developing company will then design a phase 3 study and discuss the trial parameters with the FDA. Meetings between the FDA and the drug developer will be used to coordinate what type of safety and efficacy will need to be shown for a molecule to be defined as successful in phase 3 studies.

Phase 3 clinical studies
Phase 3 studies involve hundreds (and sometimes thousands) of patients, and while safety remains important, this is where the efficacy of a molecule is truly tested. Because phase 3, or late-stage, studies are so much larger than phase 1 (early stage) or phase 2 (midstage) studies, they are often the costliest and most time-consuming portion of the drug development process.

This is also the stage where investors can get a true feel for the efficacy and safety of a drug. Thus, it's the point at which we can expect potentially wild swings in the underlying stock price of a drug developer (depending on its current portfolio and sales). Whereas positive phase 3 results can lead to substantial stock gains, a failure in phase 3 trials can be devastating. Just ask Eleven Biotherapeutics' shareholders who saw their stock nosedive 80% in March following EBI-005 not meeting its primary endpoint in dry eye disease.

Generally speaking, if a molecule meets its primary endpoint in phase 3 studies it'll be moved to the next step of the process, which is the new drug application filing. At this point the drug has been in the development process for about a decade.

New drug application filing
If a molecule meets its primary and/or secondary endpoints in phase 3 studies, then it's likely that the innovating company will file for a new drug application, or NDA, with the FDA. The purpose of the NDA is to get the FDA to accept a molecule for review so it can eventually approve it or reject it. This is essentially the stage where it's determined if a drug developer has enough data for the FDA to make a decision.

If the NDA is accepted, the standard review process is 10 months, although priority reviews occur within a six-month time frame. Once an NDA is accepted, a Prescription Drug User Fee Act (PDUFA) date will be set. This is the latest date by which the FDA will make its decision to approve or deny the molecule.

Source: National Cancer Institute via Facebook

Possible FDA panel review and PDUFA decision
The final step of the drug development process is the actual decision from the FDA. Prior to its decision the FDA's pertinent panel based on the molecules' indication may review the developers' data and vote on whether it would recommend approval or rejection. These meetings help give investors a clue as to which way the FDA might swing with its decision, although it is by no means a guarantee as the FDA isn't required to follow the advice of its panel (though it usually does).

The FDA can issue one of three rulings: it can approve a drug, it can outright reject a drug, or it can issue a complete response letter which states why the drug wasn't approved and what needs to be done by the drug developer to correct the concerns.

Currently, Exelixis (NASDAQ:EXEL) and Roche (OTC:RHHBY) shareholders are awaiting word from the FDA on their metastatic melanoma combo therapy of cobimetinib and Zelboraf. The combo achieved its primary endpoint of statistical significance in terms of progression-free survival in their phase 3 coBRIM studies, but even so it's no guarantee for approval, since there are no guarantees with the FDA. A decision is expected on or before Aug. 11, 2015.

My hope is that you now have a better understanding of the development process itself, the incredible length of time it takes to develop drugs, and ultimately how you can use the various steps to aid in your attempt to value biotech and pharmaceutical companies.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.