It's no secret that investing in the biopharmaceutical industry is one of the riskiest speculative plays an investor can make, yet many choose to undertake this high risk trading as every once in a while it can result in significant returns. For those of us who have followed the rules of Benjamin Graham, including separating our speculation account from our actual investing account, and only using a small percentage towards these high risk/reward shots, there are still many methods to minimize our risks.
To quote Benjamin Graham's book, The Intelligent Investor, "There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent." One of these being "speculating seriously when you lack proper knowledge and skill for it."
As a practicing physician I feel at home when it comes to researching these pharmaceutical companies, however many investors in this sector do not have the proper knowledge or skill in this sector to make an informed decision. It is my intent with this article to lay out some of the methods I use to reduce my overall risk with these speculative investments, and while many of them may seem like common sense, hopefully you can take something away from it. I will be avoiding financial analysis in this article as it will be a separate article in the future with much to discuss.
Part 1: The Technology
It's what draws us to these companies. The promising products that have the potential to become the next big thing, and in the process make us a significant profit from our investment. The medical field is filled with the monumental opportunities such as potential cancer treatments, HIV cures, DNA vaccines, improved insulin delivery systems, and a plethora of novel cures and therapeutic treatments. But how do you reduce the risk by attempting to understand the pharmacology behind them?
This is without a doubt the hardest section for me to address in this article. As I've stated before I am a member of the healthcare community with a vast knowledge making my analysis of the success rates somewhat easier. Still, even with my level of understanding I always research the potential product in several areas before I make a decision to invest. These include:
Product Information/Pharmacology/Mechanism of Action
Most of us will start at the source, the companies' website, and when all is said and done this is a great place to gather much of your research. You can typically access investor presentations that will discuss in great length how their product is made, how the mechanism of action works, the intended safety profile, and the potential market. However keep in mind it is their goal to sell their product to investors, and for this reason you must look at third party sources for analysis.
Third party sources, to include Seeking Alpha, are an absolute wonderful source to get multiple perspectives on the potential product. You can find a multitude of well formed opinions presented with supporting evidence that will discuss everything from clinical efficacy, safety profile, clinical result interpretation, and the realistic potential of success with the FDA to introduction to the market. Many of these problems will not have been discussed by the company directly, and these third party sources will many times steer you towards the questions you need to ask before deciding to invest.
For those of you who are serious in taking your research to the next level, I highly suggest expanding your research through any of the various medical journals available online. It is within these that you can find well discussed previous clinical trials that tie to many of these potential investments, and can help you better understand what you are getting into. Many time these are heavy on medical terminology, and can be a tough read even for myself, but they are an excellent source of information.
Similar Past Products
Looking at similar past products is a great way to determine the likelihood for success of your potential investment. Look for any past attempts to penetrate the market you are researching, and see where it failed. If your investment has overcome the shortcomings that caused the prior product failure, your chances of seeing it to approval are vastly improved.
A recent example of this is with Mannkind (MNKD) whose inhaled insulin product Afrezza had already been denied by the FDA in the past. By identifying why it failed:
- In this case Mannkind performed its trial with an inhaler, even though it planned on using a next-generation delivery device for the final product.
And how it is attempting to overcome the previous obstacle:
- Mannkind is completing additional trials to confirm efficacy with the next-generation delivery device before resubmitting
You can get an idea of its potential to succeed where previous failures have occurred.
Piggybacking Off of Approved Pharms or Delivery Technology.
Companies attempting to use a previously approved pharmaceutical or delivery technology have an improved chance for final approval, as the FDA has already given approval of part of the product. The risk with these types of Biopharmas can be significantly mitigated.
A recent example of this is Titan Pharmaceuticals (OTCQB:TTNP).
Titan has taken the previously approved opioid addiction medication "Buprenorphine" which is typically given orally, transdermal, or injection, and reintroduced it into the market as a rod that is implanted below the skin. By piggybacking this approved pharmaceutical onto its new delivery technology, Titan has receiving priority review by the FDA, and on March 21, 2013, the FDA Psychopharmacologic Drugs Advisory Committee voted to recommend approval.
I cannot stress researching the safety profile enough, as this is one of the big hitters when the product goes up against the FDA panel. Carefully study the available clinical data and look for any statistically significant adverse outcomes or side effects. These can make or break everything.
Part 2: The Company
When initiating your research of the company, it's always a good idea to start with their history. Look at where they have excelled and where they have failed, previous obstacles or drama that has occurred. If they have a healthy past, proceed by examining these areas at a minimum.
The driving force of the company, the level of education and experience that the staff is comprised of can be a big indication of how likely they are to succeed. While researching Inovio Pharmaceuticals (INO) a biopharma who is currently development of several DNA vaccines, I researched much of the staff background. I was surprised to find that many of them are a ex-Merck (MRK) president, vice presidents and employees who worked on the successful development and marketing of approved vaccines such as Hepatitis A/B, Herpes Zoster, and Rotavirus, to name a few. By looking at the staff I have a much improved idea of how likely this company is to actually see their product to the market.
By looking at who has partnered with this company we can get an idea of several things.
What outside entities feel confident enough in the technology to actually support the research.
What kind of research support the company is receiving from its partnerships. Whether it be manpower, technology, representation, etc.
How much funding is coming from outside sources, and how much this is relieving the debt from research costs.
At the risk of running a bit redundant, I'd like to again relate this topic to Inovio Pharmaceuticals. They are currently backed by several big ticket names to include: The National Cancer Institute, Merck, the Bill and Melinda Gates foundation, and the HIV Vaccine Trial Network. This tells me that:
These foundations and pharmaceutical entities feel extremely confident in the technology being developed and its potential in the market.
Inovio is receiving assistance with development, representation in the market, and significant funding from each.
Almost all of its funding is coming from outside sources, leaving Inovio with almost $0 in debt.
This is always good to take into consideration, even if you're only interested in one pivotal product. If the company's entire future depends on just one product, then the potential downside with poor results or a denial from the FDA is catastrophic. If the company has 5 or 6 prime candidates in its pipeline, however, the potential downside will subsequently be far less. This is also true for any approved products that are already producing revenue.
Part 3: Understand the FDA Clinical Approval Process
It is extremely important to understand the clinical approval process before investing in any Biopharma, as understanding the components and associated time frames give you an idea on the potential length of your investment and the hurdles it has to overcome.
An excellent article regarding the FDA Clinical Approval Process can be found here.
To summarize this process:
Drug development can generally be divided into phases.
The first is the preclinical phase, in which the compound is developed towards a purpose, and tested in animals. This usually takes 3 to 4 years to complete.
If successful, this phase is followed by an application to the FDA as an investigational new drug (IND).
After an IND is approved, the next steps are clinical phases.
Phase 1 focus on the safety and pharmacology of a compound
Phase 2 examine the effectiveness of a compound
In Phase 3 researchers try to confirm previous findings in a larger population, and these studies are used to demonstrate further safety and effectiveness and to determine the best dosage.
These phases require approximately 1, 2, and 3 years, respectively, for completion
The manufacturer then files a new drug application (NDA) with the FDA for approval.
After receiving an NDA, the FDA completes an independent review and makes its recommendations.
Once the review is complete this application can either be approved or rejected, or the FDA might request further study before making a decision.
Following acceptance, the FDA can also request that the manufacturer conduct additional postmarketing studies.
Overall, this entire process, on average, takes between 8 to 12 years, although it has been somewhat shortened by the Prescription Drug User Fee Act of 1992 (PDUFA) which was designed to help shorten the review time.
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To reiterate, investing in biopharmaceuticals is an extremely risky and speculative venture, and nothing demonstrates this risk more than the simple approval statistics. From conception to market, out of every 5,000 to 10,000 compounds that enter preclinical testing, only one is approved for marketing.
If you decide to intelligently speculate in this market I hope the basic principles in researching the technology, the company, and understanding the FDA clinical approval process that I have briefly outlined give you the means to help mitigate some of the risk, and hopefully maximize your potential for that rare substantial payout.