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The 2012 Nobel Prize for Medicine was awarded this week to two scientists for their work in stem cells.

John Gurdon was the first to clone an animal, using DNA from a tadpole’s cell to create another tadpole.

Shinya Yamanaka found ways to create embryonic stem cells without taking them from embryos.

The research into stem cells is still in its early stages, although incredible advances are already being made:

  • Several companies, including Cytori Therapeutics (NASDAQ:CYTX), are conducting clinical trials on patients with heart disease and those who have suffered heart attacks. Cytori has produced strong results in early clinical trials, including a much lower mortality rate in heart disease patients who were treated with their own stem cells than those who were not.
  • Scientists in Japan reverse engineered mouse skin cells into stem cells, which became sperm cells and egg cells, both of which produced offspring, suggesting that new infertility treatments could be created using stem cells.
  • Human embryonic stem cells have repaired the hearing of deaf gerbils, indicating there may be a treatment down the road for humans.

And there have been many others, including the ability to grow new muscle tissue, organs, etc. The possibilities of what stem cells may be able to do to cure disease and regenerate damaged tissue are endless.

But as optimistic as I am about the industry, the business side of it is quite difficult. Most stem cell companies are not profitable and constantly have to raise money. And while it’s easy to get excited about the possibilities both from a medical as well as a financial perspective, when investing in stem cell companies, you should always take the following precautions.

1) Know how much money the company has left. – Small biotech companies are always raising money. They tend to raise capital in drips and drabs. so they don’t dilute existing shareholders too drastically all at once. See how much cash it has on hand and how much it burns each quarter. Often, management will come right out and state how much time it has before it will need to raise more money.

This is important because you don’t want to get too diluted. For example, if you own 10,000 shares of a company with one million shares outstanding, you own 1%. If the company sells another one million shares to raise money, now you own 0.5% of the company. Your shares are now worth less than they were before the raise.

2) Don’t invest too much money in any one stock. – It’s easy to get excited about the incredible advances being made in stem cell therapy. It’s even easier to get caught up in how much money there is to be made. After all, if an injection of stem cells can regenerate damaged heart tissue after a heart attack, or create new liver tissue, or help a paralyzed person walk again, there will be billions in profits.

But the success stories will be far outnumbered by the failures, both medically and financially. That doesn’t mean you shouldn’t invest in some of these small and innovative companies, but only invest what you can afford to lose. These are highly speculative investments, no matter how brilliant the CEO or Chief Science Officer is, or how great the data looks. The biotech graveyard is filled with similar-looking companies.

3) Watch safety data closely. – I don’t care how great a drug performs, if there are safety concerns. The last thing you want to do is have money in a company that is going to have to explain to the FDA why its drug should be approved when there are safety issues. Most times, the FDA will not give it the green light.

Companies usually won’t announce the negative safety data in the press release touting how effective the drug is. You need to read what other scientists are saying or go through the company’s presentations at medical conferences and read the full data.

Keep in mind, every drug will have side effects. And not every side effect listed in the report can directly be attributed to the drug. But if certain side effects are a lot more numerous in drug treated group, that should be a significant red flag. And if the side effects are heart-related, run for the hills. The FDA will not approve a drug that could lead to an increase in cardiac issues.

I have no doubt that over the next few years, we’re going to witness amazing discoveries that will lead to the treatment of previously untreatable or difficult to treat diseases, conditions and injuries.

A lot of money will be made along the way. But even more will be lost by over-eager investors chasing the dream. Follow the three steps above to make sure you’re not in the second group.

Disclosure: Investment U expressly forbids its writers from having a financial interest in any security they recommend to our subscribers. All employees and agents of Investment U (and affiliated companies) must wait 24 hours after an initial trade recommendation is published on online - or 72 hours after a direct mail publication is sent - before acting on that recommendation.

Source: 3 Steps For Not Getting Burned Investing In Stem Cell Stocks