I have always had a soft spot for the scientific sectors such as biotech given my educational background in molecular medicine. So, when I first started investing, I naturally gravitated towards investing in biotech. The most important lesson I learned was that while great returns can be made, they do not come without risks.
In the grand arena of stock market investing, few sectors possess the thrill and excitement of the biotechnology industry. With its futuristic premise, seemingly limitless potential, and momentous breakthroughs, it is an investment terrain that screams opportunity.
However, the mantra, “high risk, high reward,” rings especially true in this sector. In this blog post we will take a closer look at the most important aspects when investing in biotech stocks and what you need to consider when determining for yourself if the potential rewards outweigh the risks.
The opportunities of biotech
The biotech industry stands at the forefront of modern healthcare, shaping and reshaping our understanding of medicine. When you invest in a biotech company, you are essentially backing the innovation that might revolutionize health and medical treatment as we know it.
Take Moderna Inc. (NASDAQ: MRNA), for example. Before the COVID-19 pandemic, this biotech company was relatively unknown outside the sector’s inner circle. However, their application of mRNA technology to create one of the first approved vaccines against the novel coronavirus catapulted them onto the global scene. Moderna’s stock shot up from around $20 at the start of 2020 to a high of over $400 per share in August 2021, a dazzling 2000% increase.
Investors in Regeneron Pharmaceuticals (NASDAQ: REGN) also experienced remarkable gains. The company’s creation of an antibody cocktail to treat COVID-19 pushed their stock price up by more than 50% during 2020. These instances demonstrate the huge potential returns biotech companies can provide for shareholders when their research and development efforts pay off.
Beyond these pandemic-driven success stories, the broader scope of biotech remains vast. Companies like CRISPR Therapeutics (NASDAQ: CRSP) are pioneering gene editing techniques that could lead to treatments or even cures for a host of genetic disorders, offering investment opportunities with potentially transformative outcomes.
The risky landscape of biotech
However, it is not all rosy. Investing in biotech also brings a suite of considerable risks, often stemming from the very innovation that makes it so appealing. Simply put, groundbreaking scientific research is a high-stakes gamble.
Although the biotech industry has seen some blockbuster successes, it is important to remember that these are often the exception rather than the rule. Many more biotech companies face challenges and even failure than those that achieve spectacular success.
When we talk about failure rates, we are primarily discussing the rate at which drugs fail to pass through clinical trials. These trials are designed to thoroughly test a drug’s safety and efficacy before it reaches patients, and the process is rigorous.
According to a report by the Biotechnology Innovation Organization the overall likelihood of approval from Phase I (the first stage of clinical trials) was estimated to be less than 10%. This means that for every 100 drugs that enter Phase I trials, fewer than 10 are expected to get approval.
The development cycle in biotech can be lengthy, and the path to product commercialization challenging. A company may spend years, if not decades, in the red, consuming investor capital with little to no revenue in return. Moreover, the complexity and strict regulations surrounding drug approval processes, like those conducted by the U.S. Food and Drug Administration (FDA), add further layers of uncertainty.
Take, for instance, Biogen Inc.’s (NASDAQ: BIIB) tumultuous journey with their Alzheimer’s drug, Aduhelm. Despite receiving FDA approval in June 2021, the process was mired in controversy and doubt due to concerns about the drug’s efficacy. This resulted in a rollercoaster ride for investors as Biogen’s stock price fluctuated wildly in response to news and developments.
The risk of clinical trials
In the biotech world, new treatments and medicines must go through a process known as clinical trials before they can be approved for public use. These trials test new drugs to see if they are safe and effective. Sounds simple, right? Unfortunately, it is a bit more complex, and these trials pose a significant level of uncertainty for biotech companies and their investors.
As such it is important to understand the concept of these clinical trials, which are required for the drug to become approved by regulatory authorities. Clinical trials happen in phases:
- Phase 1 usually involves a small group of people to test the safety and dosage of a new drug.
- Phase 2 expands to more people to further evaluate safety and measure effectiveness.
- Phase 3 trials test the new drug in large groups of people against a placebo or a different treatment to confirm its effectiveness.
The catch? Not all drugs make it through these trials. As previously mentioned the approval rate of phase 1 clinical trials is less than 10%. A drug might show promise in the early stages but might fail in later stages for a variety of reasons. Such as not being as effective as existing treatments, having harmful side effects, or being too difficult or expensive to produce.
When a drug fails in clinical trials, it can result in a significant loss of money for the biotech company. That is because they spend all of their time and investor funding on research and development of their innovative drug solutions. When the news hits that a drug has failed, it can lead to a big drop in the company’s stock price.
For example, in 2019, Biogen had to halt two Phase 3 clinical trials for a promising Alzheimer’s drug when it became clear that the drug was not delivering the expected results. This resulted in Biogen’s stock price falling by nearly 30% in a single day.
While you might read and hear about how comfortable or perhaps uneasy you should be about a clinical trial, the truth is no one knows for certain. A clinical trial can always flop, even in phase 3. An unexpected side effect can occur, or perhaps the drug simply does not reach the required level of efficacy consistently over longer time in large cohorts of patients.
What does this mean for you as an investor? It means that investing in biotech stocks can be somewhat of a rollercoaster ride. The anticipation of clinical trial results can drive up stock prices, but the reality of failed trials can send them crashing down.
Balancing risk and reward
In light of these potential rewards and risks, how should investors approach biotech stocks? Here are three key points to consider:
1. Diversification:
One way to mitigate the risk of investing in biotech is through diversification. Instead of placing all your bets on a single company, consider a basket of biotech stocks or a biotech-focused exchange-traded fund (ETF), like the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB).
An important aspect to also consider is whether the company has multiple drugs in development. Think about it this way. Should one of the primary clinical trials fail, then what? Does the company have alternative possibilities to reach the market and become profitable, or did they put all their eggs in one basket?
Learn how to diversify your portfolio and mitigate risks.
2. Understanding the Science:
With the technical nature of biotech, it helps to understand the basic science behind the company’s research. It does not require a Ph.D. or Doctor degree. A good grasp of the company’s product pipeline and the diseases they target will better enable you to make a sound judgement of the future prospects of the company.
It can be beneficial to learn the basics of clinical drug development to better understand the significance of the different phases. Each clinical trial phase will significantly impact the perceived value of the stock.
3. Staying Informed:
Biotech is a dynamic sector that moves fast. Regularly monitoring news about your chosen investments and the broader industry can keep you on top of crucial developments that might impact stock performance.
You have to be on your toes and make sure you are always informed about the latest market developments. How are the drug development trials going? What other market dynamics could potentially affect the need for this solution, and the future position of the company?
Conclusion: Should you be investing in biotech?
The biotech sector holds the promise of astronomical returns and being a part of exciting new advancements in medicine, but these prospects come with substantial risks.
Investing in biotech is not for the faint-hearted, but for those who can stomach the risks and uncertainties involved, it can be an exhilarating venture into the future of healthcare.
Always ensure your investments align with your investment strategy.
