The Commandments of Biotech Investing
By Brian Lawler
Anyone investing in the biotech sector can tell you it takes only one mistake or overlooked aspect of a company for you to instantly lose 40% or more on your investment.
The first step to avoiding these types of losses is to understand the patterns that emerge over time in the biopharmaceutical companies that suffer such drops. I'll call these patterns my Biotech Commandments.
As with anything in biotech, these rules don't hold for all companies. There will always be exceptions to these commandments, but in general, if you pay attention to them, you can avoid, or at least be prepared for, any biotech landmines that may be lurking ahead.
Biotech Commandment I
Drugs that fail their primary endpoints in clinical trials yet still get submitted to the Food and Drug Administration, in their creators' hopes of gaining approval based on some data mining or retrospective statistical analysis, usually do not get approved.
Back in 2004, longtime Fool biotech guru Charly Travers wrote about the problems associated with data-mining clinical trials when drug companies shoot for drug approval. A more recent example occurred last year, when Abbott Labs (NYSE: ABT) tried to get its cancer drug Xinlay approved after it showed that the drug might have a positive effect on a subgroup of patients treated with it. Abbott did this even though the drug had failed all of the primary endpoints in clinical trials.
Officials at the FDA advisory board meeting for Xinlay were not impressed with Abbott's data mining and unanimously voted to reject the drug for approval. It was no surprise: Very rarely do drugs failing all of their primary endpoints gain approval. So be wary if a company's management says that it's going to file for approval when the drug in question has failed its primary endpoints.
Biotech Commandment II
Biotech companies located on the Pink Sheets, over-the-counter exchanges, or even the American Stock Exchange often make for lousy investments.
The development-stage biotech stocks that populate these exchanges often have to raise funds via share offerings, and they generally just aren't large enough, don't attract enough investor attention, and lack the type of liquidity to avoid raising capital at prohibitively expensive rates.
Biotech Commandment III
Expect volatility in the share price of biotech stocks whose companies don't have revenues or approved drugs.
Biotech companies without any revenues often experience dramatic swings in their stock prices -- swings based largely on the whims of the market, or changes in the prospects of the larger biopharmaceutical companies, like Genentech (NYSE: DNA) or Amgen (Nasdaq: AMGN).
Examples of this phenomenon abound. One good example is Rule Breakers selection Exelixis (Nasdaq: EXEL), which is years away from any meaningful sales or royalties from its early-stage cancer drugs. Even though the prospects for Exelexis have not changed much in the past year, shares in the company have fluctuated from $6.53 to $12.49. That's some major volatility.
Biotech Commandment IV
Drugs formulated to treat certain types of diseases have a much harder time gaining regulatory approval than do other drugs.
Drug candidates in the areas of pain management, Alzheimer's disease, or several of the autoimmune diseases such as Crohn's disease, or drugs for patients not responding well to a standard of care, tend to have larger hurdles to overcome in successfully showing efficacy and ultimately gaining regulatory approval.
The history of biotech is littered with the failure of drugs in these areas. The lack of success getting drugs approved in these indications is due to many instances of the placebo effect, high patient dropout rates, or lack of knowledge of how the disease works.
Take Alzheimer's disease, for instance. There are still numerous theories on how the disease works, and multiple drugs are being developed based on these theories. It may be discovered that Alzheimer's attacks the brain in multiple ways, yet some drugs will undoubtedly have been developed based on incorrect theories and will ultimately fail.
Even if a drug to treat Alzheimer's does show efficacy in early non-randomized clinical trials, it could still fail when taken in randomized late-stage trials in which the placebo effect is reduced. Without knowing much about how Alzheimer's disease works, though, handicapping which drugs will succeed and which will fail is next to impossible.
Biotech Commandment V
As a clinical trial's size and length increase, so do the complexity and probability that something may go wrong.
Drugs-in-testing intended to treat chronic disorders, such as diabetes or multiple sclerosis, or more common ailments affecting a large group of the population, such as high blood pressure or other cardiovascular-related problems, require large and lengthy clinical trials. Thus, clinical trials in these therapeutic areas are much more prone to cost overruns and trial delays.
The upside, though, is that it becomes much easier to show a drug's benefit when it's being tested in a large clinical trial. The larger a clinical trial is, the smaller a drug's benefit can be and still show "statistical significance" -- the probability that the results seen in patients who received a drug is due to the drug and not to chance.
Biotech Commandment VI
Charly Travers proposed this one on the Rule Breaker biotech discussion board: Stay away from unproven technologies. You have no idea whether the tech even works in people, let alone the specific drug you're investing in.
Antisense and cancer vaccines are good examples of drug technologies that are still very early in their scientific lives, despite many years of research and development. Numerous companies, among them Cell Genesys (Nasdaq: CEGE) and Dendreon (Nasdaq: DNDN), are working on cancer vaccines in various indications, but as of today, no company has yet received regulatory approval for a drug in this class. It could be years before drug candidates in these therapeutic areas start bringing in meaningful revenues.
Today, the current hot class of drugs is monoclonal antibodies, or mAbs. Lots of companies have profitable mAbs, including Biogen IDEC (Nasdaq: BIIB), Genentech, and Amgen. But even though the technology has proved its viability, it still took many years for mAbs to go from discovery to actual approval. As Charly has said on a number of occasions: Drug development takes years, which makes
investing in biotech a marathon and not a sprint.
Conclusion
In no way is this a complete list of Biotech Commandments, and while a company possessing any of the bad characteristics we've mentioned here isn't necessarily an investment time bomb waiting to explode, it might be riskier than the average biotech.
Since long-term successful biotech investing requires accurate risk assessment, you must be aware of the risk you're taking on. Just as with any prospective investment, if you diversify your biotech holdings, you can somewhat mitigate these various risks. Fool analysts Karl Thiel and Charly Travers do just that with their biotech picks in the Rule Breakers newsletter. You should, too
The Commandments of Biotech Investing, Part 2
By Brian Lawler
October 9, 2006 |
Understanding and researching biotech stocks can be one of the most complex tasks for any type of investor. There are numerous considerations that need to be taken into account, and forgetting any one of them can be disastrous for your portfolio's health if you are invested in biotech companies.
Last month, I described some of these important rules to keep in mind when wading into the land of biopharmaceutical stocks. Thanks to some great reader responses, we're offering some more commandments that should never be forgotten for anyone investing in this sector. The first six commandments can be found here.
Biotech Commandment VII
When looking at clinical trials of a drug and evaluating its prospects for approval, don't focus on just the benefits or efficacy of the drug candidate. Be sure to study the seriousness and prevalence of the adverse events that occur in a drug's trials, as well.
A drug which has the possibility of terrible side effects oftentimes won't gain approval. Even if it does get approved, it may not have a high level of sales due to its risk-reward profile. According to a journal article in Modern Drug Discovery, 31% of drugs fail in clinical trials because of lack of efficacy, but almost as many, 22%, fail because of excess toxicity.
Last year, Elan's (NYSE: ELN) multiple-sclerosis drug, Tysabri, wasn't temporarily pulled from the market due to any doubts about its efficacy, but rather because of fear about patients developing a rare and deadly disease because of the drug.
So a drug's benefits need to be weighed against its side effects, because sometimes a drug with lots of benefits might not be as highly prescribed (or likely to gain approval) as a drug with fewer benefits but also fewer side effects.
Biotech Commandment VIII
Investing in companies with earlier-stage pipelines provides opportunity for larger rewards but comes with larger risks than investing in biopharmaceutical companies with late-stage or marketed drugs.
One oft-cited journal article found that only 20% of drug candidates reaching phase 1 clinical trials will eventually make it to market. Thus, investors taking a chance on companies with earlier-stage pipelines are often at a much greater risk of large share-price declines than those who invest in biopharmaceutical companies with compounds in phase 3 trials or newly approved and marketed drugs.
Another point worth adding here is that the average cost of bringing a drug through the whole clinical trial process and to market (assuming it can get that far) is more than $800 million. Thus, a revenue-less development-stage biotech won't have the resources to overcome multiple drug failures, whereas a large pharmaceutical company like Eli Lilly (NYSE: LLY) can afford a few mistakes in the clinic.
Biotech Commandment IX
With the one constant of all biopharmaceutical stocks being their volatility, investors can take certain actions to mitigate the risks of investing in this field.
If your investment is going to change dramatically due to a binary result like a Food and Drug Administration approval decision or upon the release of a clinical trial, it sometimes can be prudent to hedge the risk of a negative outcome by using options.
Another good point -- made by Motley Fool member PuddinHead on the Fool's biotech message board -- is that investors need to be aware of the risks of drug stocks and be careful not to overweight themselves in shares of any one company. All potential biotech investors should remember this point, because nothing is certain in the land of biotech. The value of a biotech stock can drop by more than 50% overnight on the revelation of a new negative drug interaction, a forced FDA label change, or the pulling of a drug off the market (which occurs at the rate of almost two a year).
Biotech Commandment X
The success of a biotech investment is based not only upon a biotech company successfully bringing new drugs to market, but also on a host of other factors outside the company's control.
There are very few drugs in development that will be used in indications with no already approved treatments. Many diseases such as heart ailments, cancer, and diabetes have numerous drugs already approved to treat them. Thus, for a newly approved drug to achieve a high rate of sales, the new treatment must have superior efficacy, a better side-effect profile, or more convenient dosing (or a combination of those). Therefore, it is important to research not only the drugs in the clinic of the biotechs you own, but competing drugs as well.
The other big outside considerations that deserve attention are the regulatory agencies that give the thumbs-up or thumbs-down to all drugs. Getting a sense of how certain drugs are faring at the FDA or EMEA usually provides hints about similar drugs' chances of garnering approval.
A more nebulous variable exogenous to the biotech stocks you may own, but still potentially just as vital, is the political climate and potential laws that are always swirling around in Congress. Potential laws that could pave the way for bio-generic drugs, mandatory government-sponsored health insurance, or rigid price caps on drugs would all dramatically change the biopharmaceutical sector. Even the perception of the level of conservatism among the politically appointed leaders of the FDA matters when it comes to biopharmaceutical investing.
Concluding remarks
There are other essential things to look out for, like being sure to assess the quality of a biopharmaceutical company's management team and checking to see that its members have strong financial and scientific backgrounds. The more in-depth your research of a potential biotech investment, and the more you remember to follow these commandments, the better your potential for success will be when investing in this fascinating field
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j/k
Raap hem wel op op het einde van de week om er alsnog winst uit te puren.