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.
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.
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).
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 impact of DNA engineering on 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, so an investor could be forgiven for confusing the two. Yet the industries have some distinct differences. Here’s an overview:
These companies typically research and develop medicines based on artificial or chemical sources. For example, they may take a look at traditional remedies and isolate the active ingredients, turning it into a drug that can be manufactured synthetically.
Or through an act of serendipity, a pharmaceutical company may stumble across a chemical compound that can be used as a medical treatment.
Portions of pharmaceutical companies may 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.
Biotech companies, on the other hand, focus on biological processes such as DNA sequencing, genetic modification, and draw upon research from the biological sciences (including molecular biology, cell biology, embryology, etc.) to develop new products and systems that can improve pharmaceuticals, crops, and livestock.
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
What Drives Biotech Stocks?
As with any sector you might choose to invest in, biotech investing is highly influenced by different catalysts, discrete actions by the company, the industry, or regulators that might shoot the stock price up or down. In the past year, those catalysts have been most visible in the biotech pharmaceutical industry, where drug companies are competing to bring Covid-19 vaccines to market — and FDA approval or CDC commentary can spark 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 Food and Drug Administration for emergency use approval for its Covid-19 vaccine. The stock went up 13 percent just on the news of that application alone, following a month of increases when the company released data showing the vaccine was effective.
These types of industry drivers — data releases from clinical trials and news from regulators — can have an outsize impact on some companies. 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 so-so trial results for a drug targeting a form of muscular dystrophy.
In early September 2021, Apellis Pharmaceuticals shares fell 43% on news of mixed results for a late-stage clinical trial of their treatment for a disease that causes vision loss.
And in late October, on news that the FDA had approved booster shots of certain Covid-19 vaccines, and that people can get a different booster shot from their original vaccine (widely called mix-and-match), many analysts forecast price increases for some companies, including Pfizer-BioNTech.
In the chart below, are some of the biggest players in this space, based on market cap and an average 3-month trading volume of more than 200,000 shares.
|Company||Market Cap||Avg. 3-month volume|
|Johnson and Johnson (JNJ)||$430.83B||5.85M|
|Roche Holding AG (RHHBY)||$336.74B||1.02M|
|Novo Nordisk A/S (NOV)||$242.79B||1.05M|
|Pfizer Inc (PFE)||$241.51B||32.12.M|
|Eli Lilly and Company (LLY)||$232.15B||2.53M|
Source: Yahoo Finance, as of 10/22/21.
What Role Does the FDA Play?
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.
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.
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 U.S. Food and Drug Administration (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. 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:
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.
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.
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.
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.
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.
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.
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.
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