There are some companies you invest in because you know their product, how much money they make with it and believe in the growth projections.
When a restaurant chain tells you they are opening up 30 restaurants this year, you don't doubt them.
But with biotechnology companies, those engaged in the research of cures or treatments for diseases, almost none of this is true, especially for those without a drug that has yet been approved for sale.
Yet investors love to gamble on the biotechs.
I know what you think. That it only takes one of them to hit a home run and you'll be rich.
But which ones? And what if you guess wrong?
It's a risky game, but there are ways to lessen the risk.
3 Guidelines for Picking the Best Biotech Stocks
1. Trust the Covering Analysts
With the biotechnology companies, where so much relies on research, trials and published papers, it's best to rely on the analysts.
The analysts are the ones sitting in on the company conference calls, attending the medical conferences, and the closest to the management. They may even attend meetings with management which gives them additional insight.
Since most of us can't afford direct access to their research, another way to follow along with the analysts is to follow all of the financial news on a company because analyst upgrades or downgrades will be reported there.
Also, track the analyst estimates. You might not have access to the actual reports but on some financial sites like Zacks.com, you can actually see how many estimates have been cut or raised over a given time period.
This provides insight into what the analysts are thinking.
2. Earnings Should Be Rising
Many small biotechs don't have any earnings because their drugs are still in development.
But as an investor, what you want to see are those analyst earnings estimates actually moving in the right direction. Even if they still remain in the negative for this year and next, look for estimates being raised, and not cut.
Buy biotechs with rising earnings estimates, not falling.
3. Worried? Buy in the Later Stages of Trials
Companies go through several phases in order to get the drug approved by the FDA.
Phase 1 is the smallest, and easiest phase. It usually involves just 20 to 100 patients. 70% of the drugs pass this phase.
Phase 2 can be several hundred patients. These trials can last months or years. Just 33% of the drugs pass this phase.
Phase 3 is tested on a larger test group of patients, usually numbering in the thousands. Just 25-30% pass this phase.
There's a Phase 4 where even more testing is done, usually involving an even larger number of test patients, to test the drug's safety and efficacy.
Once the company has sufficient data, then it can file a marketing application.
As you can see, many drugs don't pass various of the phases. If you want to improve your odds of owning a biotech company with a viable drug that it eventually can sell to patients, you should be buying in after the company has passed several of the phases.
There's still no guarantee, however, even if a company's drug makes it to Phase 3.
And the stock might not be as cheap at that point, as other investors might have bid it up in anticipation of a drug getting approved, but your risk is at least reduced.
3 Stocks That Follow the Guidelines
1. Juno Therapeutics
2. Genocea Biosciences
1. Juno Therapeutics (NASDAQ:JUNO)
Juno develops T cell-based immunotherapies for cancer. It has 8 products in clinical trials against 6 targets.
Several trials are advancing in 2016 with some analysts believing there could possibly be a product launch in 2017.
Juno isn't one of those small cap biotechs that may not have enough money to complete its trials. It has a market cap of $4.5 billion and $1.22 billion cash on hand as of the end of 2015.
While it isn't yet making money, the estimates are moving up as 1 estimate was raised for 2016 in the last 60 days.
The Zacks Consensus Estimate rose to a loss of $2.09 from a loss of $2.53 in the last 60 days.
It's a Zacks Rank #2 (Buy).
2. Genocea Biosciences, Inc. (NASDAQ:GNCA)
Genocea is developing vaccines enabled by a T-cell antigen discovery platform primarily for herpes simplex 2, but is also in the early stage process for chlamydia, malaria, and Epstein-Barr virus.
On March 31, the company reported positive 12-month top line data for its Phase II dose optimization trial for herpes simplex 2.
Genocea indicated that it will meet with the FDA for its "end-of-Phase II" meeting in the first quarter of 2017. Phase III is expected to start in mid-2017.
The herpes market is large. Doctors have been awaiting any treatment, even one that reduces symptoms.
Genocea is a small cap with a market cap of just $187 million.
But the analysts like what they heard about Phase II and raised estimates.
1 estimate has been raised since the company released the results but 4 are up in the last 60 days.
The 2016 Zacks Consensus Estimate has risen to a loss of $1.73 from a loss of $1.89 in the last 60 days.
Genocea is a Zacks Rank #2 (Buy).
3. Merrimack Pharmaceuticals, Inc. (NASDAQ:MACK)
Merrimack focuses on cancer therapies. It has a market cap of $1 billion and 6 drugs in clinical trials.
It actually achieved the holy grail of biotechs by getting a drug approved by the FDA last year. Onivyde, a pancreatic cancer drug, was approved in October 2015.
While this is great news, it does mean its marketing costs will rise.
It also recently announced that it was filing a Phase II amendment for its MM-121 drug, which is for lung cancer, with the FDA. It expects top line data in 2018.
Financially, it recently closed private placement of $175 million in senior secured notes due in 2022 so it has cash on hand. It also has several partnerships with other companies to defray costs.
Estimates are moving in the right direction for 2016. Analysts now expect Merrimack to lose $0.81 versus a loss of $0.88 just 60 days ago.
Merrimack is a Zacks Rank #3 (Hold).
Do Your Homework
The biotechs that aren't yet making money are a gamble.
That's why some investors love them. They hold the promise of future glory.
But make sure you do your homework before investing.
If you can't handle the risk of investing in individual companies that may end up with no viable drugs, you can always buy the ETF that holds a bunch of these companies.
The BioShares Biotechnology Clinical Trials ETF (NASDAQ:BBC) is one that invests in companies that are still mostly in the clinical trial phase.
But even though the ETF spreads the risk among numerous holdings, the BBC is still down 27% year-to-date.
Just remember, the biotechs aren't for the faint of heart and no matter what someone says, there are no sure things in the biotech world.
Clinical trials can go bust just as quickly as they succeed.