Biotech Investors: Are We Blinded By Clinical Trials?

by: Cris Frangold

Clinical trial results, while a necessary part of the medical research process, can sometimes cloud investor judgment, causing investors to invest heavily in treatments that ultimately prove unsafe for human use or cause investors to pull out before a drug has undergone a thorough evaluation.

To receive FDA approval and approval from other medical agencies around the world, drug makers must complete at least clinical trial phases that expertly report effectiveness, safety, and potential health risks based on research, human testing, and monitoring side effects. Drug makers typically make the results of each trial public after completion. In some cases, drug makers may cease additional trials after phase I if a drug fails to produce any positive results. In most cases, additional trial phases help researchers discover more about a drug's effectiveness, amount needed to produce results, and more information about potential side effects.

It is almost impossible to tell how well a drug will perform in the marketplace based on one or two clinical trial phase results. While investors should consider the results of each phase, until a drug receives approval and becomes available to the public, actual sales/revenue cannot be known. From clinical trial results, investors may be able to determine the possibility of a drug receiving FDA approval, but again, poor results from a phase I clinical trial may not reveal a drug's full potential - which may not be discovered until phase III.

Potential Missed Opportunity

Such is the case with drug maker Aeterna Zentaris (NASDAQ:AEZS). An analyst at Maxim Group recently gave the company a Buy rating with a $9.00 per share target, suggesting that the company's (in partnership with Keryx (NASDAQ:KERX) phase I and phase II trials of anti-cancer drug perifosine were not complete failures. Even though the drug failed to produce the anticipated results, perifosine did have some positive effects, but additional tests are necessary to determine the correct dosage and other variables that could make this an outstanding anti-cancer drug. The analyst stated that phase III trial could prove the drug's effectiveness.

The main argument for buying or holding existing Aeterna Zentaris stock lies in the presumed effectiveness of perifosine. Additional trials may provide the information researchers need to enhance the drug's performance and make it a viable ally in the fight against certain types of cancer. Investors that pull out now may miss the opportunity to cash in later on once the drug is approved and the stock price goes up.

Faster FDA Approval

According to FDA Commissioner Margaret Hamburg, shortening clinical trials by reducing the number of participants needed to complete an adequate drug testing for life saving drugs such as obesity and antibiotics may become a reality soon. For morbidly obese patients, receiving new drugs that help in controlling weight gain could lengthen their lives and allow patients to adopt healthier lifestyles before developing diseases such as diabetes, cancer, or heart disease.

Shorter clinical trials may also keep investors from dumping stocks too early. Since most clinical trial phases can take a year or longer depending on the disease or condition the drug supposedly helps treat (this means some trials take five years or more to complete), investors will now see a quicker return on their investments due to faster FDA approval and entrance into the marketplace.

On the other hand, shorter clinical trials may prevent researchers from adequately accessing potential risks. In the past, the FDA has pulled other obesity drugs like Fen-phen from the market after reports of harm and death to patients. This caused many investors to lose money very quickly - but also placed more emphasis on the importance of clinical trials.

Clinical Trial Results and Insider Trading

By the time a drug reaches a phase III clinical trial, researchers have a much better idea of whether a drug will be effective or not. Clinical trial information, prior to publication, remains with researchers and company officials. Unfortunately, studies conducted within the research community have found some evidence of insider trading that directly affect company stock price. Even though proving unethical stock trading has taken place is difficult, investors should give consideration that prices may be affected slightly due to unethical behavior.

More to Analyze than Clinical Trials

Investors should carefully review all information available about new drugs including clinical trial results, research methods, and company financials before making any hasty decisions. Clinical trial results, unless drug makers discontinue future trials, should serve as a way to show progress towards developing and manufacturing new drug treatments.

When investing in biotech and pharmaceuticals, investors should also pay close attention to a company's portfolio. Companies like Abbott Laboratories (NYSE:ABT) have a diverse portfolio with many drug treatments on the market. Other companies like Dendreon (NASDAQ:DNDN) have one. For smaller companies, clinical trials carry more weight, only because these companies have limited portfolios - companies with many products can still provide a return for investors while companies with one or no products cannot guarantee continued profits.

In the end, clinical trials help investors predict future earnings somewhat, but should not be the only marker when it comes to turning a profit in pharmaceuticals and biotech. Judging the earnings potential of a drug treatment based on phase I trials may cause investors to lose money if they pull out too early.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.