Recently I have been expanding my knowledge into the biotech sector. In mid-2019 I purchased my first biotech company and had absolutely no idea what I was buying or getting myself into. Thankfully I started with small positions and attempted to learn what I could about a biotech company. Hint… they can be super confusing and I ended up selling a few months later breaking even. No harm no foul. Attempt number one in a biotech company was unsuccessful.
Fast forward to the end of 2020 and received wind of a new biotech company that was going to be groundbreaking. I had been doing well during the Covid-19 stock market craziness through SPACs and had been collecting nice sums of cash. Compared to my first attempt at a biotech I was at a whole other level financially. But this time I wanted to do it right. Full research into the company. I even did a post about it (give it a look).
My hopes were extremely high and I thought I had a good grasp on this biotech and was getting to know the sector a little better. Some takeaways I thought were important for this company were purely the science and the data. They have multiple pipelines and strong data throughout their research. So just sit back and wait for the trials to produce data making the company worth billions of dollars. Simple right? Since I invested that stock is down 70% and the biotech sector went on to have its worst year. In 2021 the biotech sector was down 34% overall (check out this NASDAQ Article).
So, round 2 in a biotech company was extremely unsuccessful. What did I learn from this experience? Well, first I gained unmeasurable knowledge within the biotech sector. Learning how biotechs operate financially, what kind of partnerships are possible, how candidates are picked for trials, what the FDA looks for in new drugs, how involved the FDA will be in approving drugs, and other factors that are important when researching biotechs.
I learned about the 3 trials for biotech companies. Such as Pre-Clinical, Phase 1, Phase 2, and Phase 3 Clinical Trials. I learned that biotechs do not generate revenue and only burn cash (overlooked this portion in my round 2 investment), that the timeline of each phase of the clinical trials can take up to and over 12 months to complete (also overlooked this), and what diseases are harder to cure and which could provide high revenue and in turn larger company valuations. So yes I lost plenty of money. But the knowledge gained through these failures will guide my investments in biotechs for the rest of my investing career.
Now onto attempt three. Another biotech company has surfaced. But no need to do extensive posts like in round 2. Why focus on science so quickly. If biotech doesn’t generate cash to fund their trials and their trials from start to finish can take over 3 years… wouldn’t it be smart to look at their balance sheet and income statement first? Figure out how much cash they have and how quickly they burn it? All this info is public at sec.gov. If a biotech can’t reach the end of its trials with the cash they have on hand then they are going to need to raise money in the future.
How does a biotech raise money? They will issue new shares at a premium to biotech funds or private investors. So by issuing new shares at a premium they are going to dilute the current share price and quantity. Driving your investment down. And what happens if they can’t raise money? Even if the science is great, if they can’t get to the release of data, their stock will tank. CASH IS KING. Only invest in biotechs that have enough cash to reach their value inflection point (end of their trails).
Next of course is to review the science and understand the data. You can look at company presents like this for data. And don’t worry if it looks super confusing, I have looked at my fair share of confusing data and graphs as an engineer. The data reports produced by biotechs can be daunting when first read. Just read them and see what you can understand. Some data is definitely understandable. At first, you want to understand what disease the drug is targeting, what the drug is doing internally, and if it is SAFE. You can have a great drug but if it is hurting some users the FDA will not approve it. Safety is a top priority for the FDA. Then comes efficacy.
Different drugs will warrant different market sectors within the biotech industry. The sector for irritable bowel syndrome (IBS) can be between $500MM to $1B. The asthma sector can roughly be $1 to $2B. Oncology can be over $2B. And something like Alzheimer’s drug can be over $10B market sector. The largest potential market sector correlates to that disease/drug that is very hard to treat with minimal treatments currently available.
Something else worth mentioning is reading through stock ownership. It is uncommon for CEOs, CFOs, and other upper management to invest their personal money into the biotech company. Seeing them invest (have skin in the game) is comforting but doesn’t guarantee success. Also, there are large biotech funds out there that will take up positions in certain biotechs. You can follow them over time and see who they invest in and if they ultimately pick winners.
The stock for my round 3 investment was also distressed with the current market conditions. The biotech sector is hurting significantly. Covid-19 pulled the FDA’s attention out of biotechs and had them focus on approving vaccines for the pandemic. This was a big hit for the sector.
A new strategy I am working to implement is the risk and reward when purchasing a biotech. The obliviously biotech sector is one of the top sectors in terms of significant gains. You can obtain 300%, 500%, 700%, 1000%, and even 3000% returns on some biotechs if everything plays off perfectly. In terms of time spent invested to potential returns there is no better place to be. In the industry, we call this a Multi-Bagger!
That being said biotech companies can also tank and drop 50%, 60%, and 80% overnight and you lose all your money. But thankfully you can calculate this drop. Biotechs hold lots of cash as discussed before and if they fail they will settle to around what their cash position is. Just use sec.gov to determine how many shares are available and you can estimate what the price of the stock would be in the case of a stock failure.
So for my round 3, the biotech that has surfaced checks off lots of boxes. First off they have plenty of cash! They have so much cash they can double what they spend a year and still be able to complete their trails. Second, they are attempting to treat a disease that has minimal current treatments, these treatments do not work and barely slow down the effects. They are attempting to treat this disease in a revolutionary way, and their pre-clinical and phase 1 trials have proven strong data to go off of.
Third, the drug itself has been proven to be safe for people with and without the disease. Fourth, they have so much cash the downside is minimal compared to the potential upside. The risk/reward play here is great and it is what excites me the most. I am risking $4.60 per share with the chance of earning over $50 per share. Lastly, the board of directors, CEO, CFO, and others have placed their own money into the company.
This is the ideal setup you want to look for in a biotech company. Just remember with high rewards comes high risk. Happy Trading.