I get questions all the time from investors who are interested in biotech stocks. The promise of a blockbuster drug like Viagra has them thinking of huge profits. Here are a few rules that should be applied when buying development stage biotechs. This is not for established, profitable companies like Amgen. It’s for the companies that are working on one or more drugs but have no sales.
Realize that without a PH.D. in biochemistry (and usually not even then) the average person has no chance of figuring out if a drug or treatment can succeed. It sounds promising, but they all sound promising, otherwise the company wouldn’t develop it. With that in mind, these are the rules that I think should be applied.
- Pick a company that has a large potential market. A non-injection insulin delivery system for diabetics would have huge application. A drug for treatment of liposuction complications would be much less.
- Pick a company with enough cash to go for awhile. Bankruptcy is the biggest problem for most of these companies. So picking ones that have money to pay for their research is common sense. If they don’t have cash I would make sure that at least they have commitments for more and not just plans for getting more.
- Buy a lot of them. Since the average person has little chance of picking the winner, it makes sense to diversify the risk. If someone buys 3 biotechs and none come to market with a product, they could lose their entire investment. So instead of buying 1 or 2 or 3, I’d suggest buying 8 or 10 or 15. That way the big winners pay for all the other loses. If an investor couldn’t afford to buy that much stock I’d suggest using a mutual fund instead.
The allure of buying biotechs is an exciting one when thinking about those blockbuster drugs. But an investor should prepare for the downside and risks as well.