How to Invest in Biotech Stocks

Investing in biotech companies might not be for the faint of heart, but it isn’t an impossible industry for the average investor to profit in. Smart investing in biotech can actually be rather lucrative. The problem is that there’s lots of bad advice out there, from a neighbor that offers you “hot stock tips” about companies trading on the Pink Sheets to well-known financial media outlets that promise to help you time the market, which is never a great idea.

Here you will find some legitimate tips for helping you avoid some of the usual pitfalls and earn a tidy sum investing in the biotech industry.

1. Follow in the Steps of the True Experts in the Industry

It is safe to bet that unless you have a Ph.D. in biochemistry the sharp minds that run the leading pharmaceutical companies have a better idea of what to look at in the biotech industry’s pipeline than you do. To take advantage of their expertise is to check where they are placing their money.

For example, Celgene shares a very strong bond with Juno Therapeutics at this juncture. CAR-T immunotherapy developers out there are in plenty, but it was Juno that Celgene settled on for a partnership deal worth $1billion involving an equity investment and access to Juno’s pipeline. It is a vote of confidence in the ability of Juno to be the CAR-T developer to watch, and you should think long and hard before investing in its competitors as it’s one of the top biotech stocks.

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2. Watch Out for Cash Burn

It's important that you check out the companies financials. Small biotech companies are actually losing money. If you invest in a clinical-stage company, you are essentially investing with the hope of receiving a share of the potential future revenues, and you should be aware that profitability is still not there yet. That is not necessarily a negative. However, if the biotech’s cash reserve is quickly getting depleted, you should be ready for your future slice of pie to reduce too.

One of the greatest reasons why the share prices of biotech companies fall is shareholder dilution. If you wish to protect yourself, you need to calculate the cash runaway by dividing the amount of cash available to the company with its annual expenditure. If you find the result to be less than a year, it is a strong sign that dilution will soon come up.

A good example is MannKind Corporation, which is a company that has had multiple rounds of share offerings each increasingly diluting its shareholders as it continues struggling to market the only drug it has, which is an inhaled insulin known as Afrezza.

The shares recently dropped a whopping 27 percent in one day upon the announcement of yet another round of shareholder dilution. The move would have been hardly surprising to those keeping an eye on its cash level. Even the management made it quite clear that its cash reserves were only enough to keep the lights on until the end of 2016.

3. Don’t Invest Emotionally

The biotech industry is full of emotion and it is not hard to see why: It is all about companies with the potential to ease human suffering and save lives. It is also an industry that attracts an incredible number of investors that are sometimes greedy. Whether the emotions are genuine or not, the industry is still volatile.

Investment advisors usually keep tabs on all the publicly traded and reasonably sized companies and if one moves 10 percent in either direction (up or down), they usually write an article to explain the reasons why. If you check such articles you will find remarks such as “The biotech industry is too volatile and that there’s no new news on the company”. The articles serve as an important reminder that you should not worry about the daily share price fluctuations that have no bearing on the investing thesis.

Never take your eyes off the prize and never buy high and sell low simply because the market has had a rough couple of days. Being levelheaded is critical to long-term investing and that’s how you can make real money from an investment portfolio.

4. Determine Your Risk Tolerance

If you're looking to invest in biotech stocks, one of the most important steps to take is determining your risk tolerance. Are you willing to invest more aggressively or are you risk-averse?

Knowing where you fall on the spectrum can be critical because it'll help you when picking out different biotech stocks. Some stocks are really risky can “tank” in a day due to clinical failures or not getting regulatory approval from the Food and Drug Administration (FDA) or the European Medicines Agency in Europe. So if you wanted to avoid the risk — you are risk-averse and can pick good biotech stocks for you.

Here is an example of different biotech stocks/ETFs and the risk tolerance they bring:

5. Know What to Look For in a Biotech Stock

When you're looking at different biotech stocks make sure you find one with a great spectrum of already approved rugs on the market. That means that these drugs are already selling and making billions of dollars of sales each year.

Not only that, but you want to see that the company has drugs in the pipeline that they are testing (preferably phase 3 testing).

It may be difficult to find a perfect candidate, as many smaller biotechs don't have any approved drugs yet. However, a biotech company that several drugs in late-stage testing is one that you should be keeping an eye on and investing in.

The Bottom Line

Investing in biotech stocks is pretty scary. However, if you keep these five tips in mind then you're odds of choosing lucrative biotech stocks rises.

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