Biotech can be an exciting and dynamic sector, and biotech investing may offer investors the opportunity to buy companies that are developing cutting-edge technologies to create life-changing medical advances and agricultural innovations.
Like the tech sector, biotechnology is known for having both established companies as well as a number of start-ups at various stages. Because the biotech industry is complex and highly regulated, there are some important things to know before embarking on biotech investing yourself.
What Is a Biotech Stock?
A biotech stock is simply a share in a company that focuses on biotechnology. The biotech industry is geared toward the study and use of biological systems and organisms to make agricultural and medical products, including drugs and other treatments.
Biotechnology sounds modern, and it is, but its origins go back to the many ways humans have manipulated biological processes in the domestication of animals, as well as the modifying and breeding of plants and crops, over time. In the last century or so, biotechnology has come to include new sciences like genomics, applied immunology, and more.
Given the rapid advances in all kinds of technologies, many believe investing in biotech — like tech stocks — is in a sort of golden age. And while biotech innovations are driving advances in many aspects of medicine, healthcare, agriculture, mental health, and more, this is not an easy sector for many investors. The potential rewards are heavily weighted with potential risks, owing to the difficulty of bringing even the most promising and successful products to market.
Investors who are considering investing in biotech companies may want to have a number of strategies at their disposal, including a basic understanding of limit orders and other trading tools.
A solid understanding of certain business fundamentals wouldn’t hurt either, since choosing solid companies will require some knowledge of how to read a profit and loss statement and other corporate reports.
The Evolution of Biotech
The medical branch of the industry focuses on the creation of new pharmaceuticals and treatments for diseases; the agriculture branch uses genetic modification to improve crops as well as livestock (e.g. to make crops pest resistant, to improve animals’ resistance to disease, and so on).
A pivotal moment in biotechnology occurred in the early 1970s, during the first DNA cloning experiments at the California labs of researchers Stanley Cohen and Herbert Boyer. Their experiments demonstrated the potential benefits of DNA engineering for medicine, pharmacology, industry, and agriculture.
Since then, modern biotech companies have largely expanded beyond the chemical-focused pharmaceutical and agricultural companies that came before them to embrace genetic engineering, design genetically modified microorganisms and cells, and even create transgenic plants and animals.
Biotech start-ups can be found around the globe, though they are often clustered near sources of venture capital, such as Silicon Valley, or in research hubs, such as North Carolina’s Research Triangle.
What’s the Difference Between Biotech and Pharmaceuticals?
Both biotech and pharmaceutical companies can produce medicines and treatments for disease, but the industries have distinct differences that investors should understand (especially for those interested in active investing). Here’s an overview:
Pharmaceutical Companies
Some pharmaceutical companies may include divisions that also focus on biotech. However as a whole, these companies may not be viewed as strictly biotech companies, because this sector is not their main source of revenue.
While biotech companies take on a great deal of risk in their quest to bring new drugs and treatments to market, pharmaceutical companies are focused on diversifying risk, by having a number of products at different stages. And typically a pharmaceutical company has at least one mainstay drug or treatment that brings in revenue.
As a result, the success — and the revenue — of pharma companies doesn’t depend solely on FDA approvals. The risks for investors are therefore lower, and the potential for returns can be higher (and many pharma companies pay dividends). That said, pharmaceutical stocks are vulnerable to problems with existing products; lawsuits; changes in regulations or policy that affect prices and can add to volatility in this sector.
Biotech Companies
Biotech companies are geared toward finding breakthrough drugs and treatments and taking them through the long, slow, expensive clinical trial process that all treatments are subject to by the FDA.
For investors, that means it can take years before even the most promising drug sees the light of day — which means that any given biotech stock may or may not see much growth over time. That could change if and when a drug makes it through all the FDA hurdles, or not. Lack of approval, or any other regulatory changes or alterations in the healthcare or agricultural markets, could skew company results.
| Biotechnology companies | Pharmaceutical companies |
|---|---|
| Geared toward R&D, focused on product breakthroughs | Focused on a marketing approved products |
| Long lead times for most projects | Have products at various stages of development, sales, and marketing |
| Lower revenue; dividends are rare | Higher revenue (due to actual product sales); dividends are common |
| Higher risk factors for investors (drug approval rates are low) | Lower risk factors (companies only deal with approved products) |
What Is a Biopharmaceutical?
Investors may also encounter the term “biopharmaceuticals,” which can refer to the drugs produced by biotech processes. For example, a biotech process known as biosynthesis can produce chemicals — including some medicines — inside cells with the aid of multiple enzymatic reactions.
If it’s used for medicinal purposes, the resulting chemical might be referred to as a biopharmaceutical.
Recommended: How to Invest in Pharmaceutical Stocks
Understanding the Biotech Industry
The biotechnology industry is unusual in that it’s a complicated, big money, high stakes, high-risk sector. Many companies are focused on developing drugs that can save or prolong people’s lives, or solve persistent problems in regard to conditions that kill animals and compromise crops. But despite having a positive aim, the drive to profit is what underscores all businesses — and biotech is no exception. And that’s where the risks can be high for investors.
Because the lead times for product development can take years, investors may not see big returns — or any returns. Some 90% of new drugs in the testing phase never meet with FDA approval.
The Role of the FDA
One of the FDA’s responsibilities is to evaluate medical treatments before they hit the market. These evaluations prevent ineffectual treatments and medicines from being brought to market. It’s vital that would-be biotech investors familiarize themselves with the FDA approval process, which is usually accomplished through some three clinical trials.
When a company develops a new drug, they first test it themselves and then send the result to the FDA’s Center for Drug Evaluation and Research (CDER).
The CDER uses a team of scientists, doctors, and pharmacologists to evaluate these results and determine whether the drug’s benefits outweigh its known risks. If they do, then the drug may be approved. If not, the drug company is sent back to the drawing board.
What Drives Biotech Stocks?
As with any sector you might choose to invest in, biotech investing is highly influenced by different catalysts, e.g. discrete actions by the company, the industry, or regulators that might drive the stock price up or down. As a result, biotech can be unpredictable, or even somewhat volatile.
In the past few years, those catalysts have been most visible in the biotech pharmaceutical industry, where drug companies are competing to bring Covid-19 vaccines to market. But no matter what the drug, approval by the U.S. Food and Drug Administration (FDA) or Centers for Disease Control (CDC) commentary can spark price swings.
Examples of Price Swings
One example would be what happened in November 2020, when the biotech company Moderna announced that it would file for authorization from the FDA for emergency use approval for its Covid-19 vaccine. The stock rose 13% just on the news of that application alone, following a month of increases when the company released data showing the vaccine was effective.
The news is not always good, however. The shares of biotech pharmaceutical giant Eli Lilly, for example, fell 9% in March 2021 after clinical trial results for an Alzheimer’s drug were not as robust as expected.
For some biotech companies, the drop-offs can be even more dramatic. In April 2021, Sarpeta Therapeutics shares fell by more than half after mediocre trial results for a drug targeting a form of muscular dystrophy.
Five of the Largest Biotech Companies by Market Cap
In the chart below, are five of the biggest players in this space, based on company market cap and an average 3-month trading volume of more than 200,000 shares.
| Company | Market Cap | Avg. 3-month volume |
|---|---|---|
| UnitedHealthcare (UNH) | $492.49B | 3.14M |
| Johnson and Johnson (JNJ) | $462.84B | 3.94M |
| Eli Lilly and Company (LLY) | $347.11B | 3.17M |
| Novo Nordisk A/S (NOV) | $302.13B | 1.33M |
| Pfizer Inc (PFE) | $289.87B | 21.49M |
Source: Yahoo Finance, as of 12/22/22.
The 4 Main Risks of Biotech Investing
As with any stock, there are risks associated with biotechnology investing, many of which are specific to the industry. Before considering these companies it’s important to understand what some of these risks are.
1. Clinical Failure
Clinical failure is one of the most important risks to understand. All biotech companies that are producing medical products must test them rigorously to assess their safety and how well the drug or treatment actually addresses the condition it targets. There is a possibility that the drug or treatment will not be effective or will prove to be too dangerous for consumption.
The process of testing begins in preclinical trials in which treatments are tested in a lab in test tubes or petri dishes without using human or animal subjects. Other preclinical trials might use animal subjects to test drugs.
Many drugs don’t make it out of this phase of testing, so a biotech startup with drugs that are only in preclinical trials may be especially risky since the future success of these drugs is largely unknown.
If a drug passes the preclinical phase, it goes on to phase 1, where the safety of a drug is tested. Then it moves on to phase 2 trials, which test dosage levels and how well the drug works. And finally, phase 3 trials are large clinical trials that test the efficacy and safety of the drug. A very small percentage of drugs make it past this final phase.
2. Regulatory Issues
Even if a drug successfully makes it through its clinical trials, it then must win approval from the FDA, as noted above. A rejection by the FDA typically means the drug will not be brought to market any time soon.
3. Developing the Market
FDA approval isn’t the end of the line, though. Once a drug is FDA-approved, biotech companies still have to convince doctors to use it, and insurers and healthcare programs to pay for it.
The company will also likely need to assemble marketing teams to promote the drug to doctors and consumers — or partner with another company to do so. These efforts can be costly and can fail to produce consumer demand.
4. Patent Expiration
Biotech companies can enjoy protection from competitors in the form of a patent for 20 years. But once the patent runs out, competitors can make their own version of the product, which typically drives stock prices down.
Choosing a Biotech Stock
There are a number of factors to consider when evaluating a biotech company, from a company’s financials to the problem it targets to how it’s managed. Before investing in a biotech company, investor may want to research the following:
Funding
It may take years for a biotech company to develop a product, license it, and earn back the money it spent developing it. As a result, investors may want to look for companies with a cash reserve of two years or more.
Investors should also investigate where a company is getting its funding and if there’s a possibility to get more. For example, can the company sell more shares to fund its development? The flip side of that process is that selling too many shares may actually be diluting the market.
Debt
Developing a biotech product can be expensive. In addition to being able to fund research, development and the marketing of a drug, biotech companies will likely have some debt to pay off. Investors may want to consider companies that aren’t overleveraged with huge loans to pay back to private investors or banks.
Support
Investors may also want to investigate what kind of outside support a company has. Small companies in particular may have a hard time going it alone, but backing from a major corporation can put them on more stable ground.
Better, yet, a company with multiple partners is even more protected, because if one backs out, the company still has support from others and won’t be left floundering on its own.
Management
While investigating a company’s financials, investors may want to do a little digging into who is managing the firm, especially smaller startups. Managers with business acumen who are knowledgeable about startups are important.
But also take into account whether a company has management with scientific credentials such as M.D.s or Ph.D.s who can understand the research and science involved in the company.
Managers with a medical or scientific background may be better equipped to understand the impact research results could have on the business side, and be able make decisions accordingly.
Area of Research
The issues a biotech company is tackling can have a big impact on its success. For example, investors may want to look to medical biotech companies that are targeting common diseases such as cancer, diabetes, or heart disease.
These diseases are prevalent, so if a drug or treatment is approved, there may be a greater chance of that product doing well in the market.
The opposite of targeting companies with products that have a broad appeal is considering niche opportunities. Orphan drugs target extremely rare diseases, for example. Because of the relatively small market for them, many companies can be loath to develop them. Thus, a firm that targets that niche may have less competition.
More Than One Product
It takes many resources to propel a new medical treatment through clinical trials and FDA approvals. It’s not unusual for a biotech company to put a lot of its energy toward the product it thinks is most likely to make it over this hurdle.
However, crossing the finish line is not guaranteed. If a new drug isn’t approved and the company doesn’t have a backup plan, investors may be left hanging. So consider companies that haven’t put all their eggs in one basket, and might have another promising product in the pipeline as well.
Market Readiness
Investors may want to keep a close eye on companies with products that are nearing market readiness. One key sign to watch out for are drugs that are in control group trials.
Phases 1 and 2 of clinical trials don’t require controls, but phase 3, the final phase of trials before the drug heads off for FDA approval, does require controls. That said, controls are an expensive undertaking, and including a control group in one of the first two phases of trials may signal a company’s confidence in their product.
Press Releases
When biotech companies alert the public to new developments there are a couple of things to watch out for. If the company seems to be sending out an inordinate amount of press releases, it may be worth double checking why.
Take a look at Clinicaltrials.gov to see the status of a company’s active trials. If there are a lot of them, those press releases might make sense. If there aren’t so many, then the company might be overstating its current capacity.
Additionally, clinical trials have both primary and secondary endpoints: different goals the company was hoping to meet. A company that touts its secondary endpoints while remaining reticent about its primary endpoints may be masking the fact that it didn’t do so well meeting them.
The Takeaway
Biotech investing is a compelling and complex market segment. Because it’s highly regulated, and individual company performance can be sensitive to industry- and company-specific events (like regulatory changes and approvals) as well as market factors, it’s wise for investors to tread carefully as they become familiar with the dynamics of this market.
Investors who have researched biotech companies and are ready to trade individual stocks can start by opening an online brokerage account. Given the higher price of some biotech stocks, it’s also possible to buy fractional shares. You can also consider trading an ETF with a biotech focus, which can provide more diversification, which can help offer some protection against risk.
Will investing in biotech stocks support your goals? When you become a SoFi Member, you have complimentary access to financial professionals who can help address important questions like this.
FAQ
Should you invest in biotech stocks?
While biotech stocks might offer the potential for a big payoff at some point, it’s also possible that a) that day may never come (given how long it takes for drug and treatment approvals in the U.S.); and b) there is also the risk of a steep loss if the company you choose has a major setback.
Is biotech a safe investment?
First, very few investments qualify as “safe,” and even with those that appear more stable, there are no guarantees. Biotech is a complex sector for many investors. It requires a combination of due diligence and patience to choose the right company or product, and stay the course until there is some success — and the resilience to deal with unpleasant fallout if a product fails to launch.
What is a biotech ETF?
A biotech exchange-traded fund (ETF) is a basket of stocks that focus on a specific biotech index or specific niche within the biotech market, such as genomics, immunotherapy drugs, agriculture, and so on.
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