When to Buy Biotechnology Stocks?

by: Ketan Desai

When to invest in biotechnology companies is pretty tricky. While investing is challenging per se, biotechnology stocks are in a universe of their own. Not only does one have to take into account macro-economic factors, but also those peculiar to biotechnology stocks. These include the science behind the compound, toxicology studies, manufacturing, clinical trials, FDA regulations and approval, and finally marketing. Getting into the stock early is tempting, with gains that can exceed several hundred percent. This chart of Pharmasset (VRUS) is one such example (all charts courtesy of Yahoo Finance).

But very few stocks make that transition; most simply don’t get that far. Even after making it through toxicology and conducting clinical trials, there is no guarantee. Clinical trials can be for the wrong indication, poorly designed, poorly conducted, and sometimes fall prey to plain bad luck as with a high placebo responder rate. And even after that, there is the FDA to contend with; it may not approve the drug. Take three examples where the FDA shot down companies in the weight loss space – Orexigen (NASDAQ:OREX) and Arena (NASDAQ:ARNA) -- and one in the diabetes space, in the weight loss space, and MannKind (NASDAQ:MNKD) in the diabetes franchise.

While one can wait for the drug to be approved, there are again no guarantees. Sales may miss targets or expectations, causing the stock to tank. Human Genome Sciences (HGSI) and Dendreon (NASDAQ:DNDN) are two recent examples of that.

So when to invest? Depends on your risk tolerance and disposable cash. If you have cash that you can live comfortably without, and have a high risk tolerance, go ahead and invest early. But make sure the science is good and the management is competent and honest. Check out their its record – see how many drugs it's brought to the market. Don’t concentrate on where it's been and what its title was – see what it's actually accomplished.

If you are risk-averse, the other extreme is not a bad place to be. Wait for initial sales of a quarter or two before investing. This strategy won’t give you the 1000% return, but can still give you great returns. As an example, take Alexion (NASDAQ:ALXN). Its technology's concentrated on antibodies to complements and had good science and good manufacturing. But it was going after the wrong indication (rheumatoid arthritis) because marketing told it that was where the money was. The clinical study in RA failed and the stock tanked. When it changed direction and went after Paroxysmal Nocturanl Hemaglobinurea, a complement dependent disease, its trials were successful. The FDA approved the drug, and the stock has since been on a tear. Even if you bought the stock two quarters after approval, you would have had a 400% return.

Immunex was another such example where you could have obtained over a 300% return after the drug showed explosive sales immediately post-approval (great company, but it got bought out by Amgen (NASDAQ:AMGN)). In summary, chose your strategy based on your knowledge of biotechnology, personal finances and risk tolerance, but know that investing after seeing solid sales is a viable option.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.