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The stock market is home to thousands of stocks from different industries. Each industry can be characterized by certain features, such as growth rate, exposure to risk, volatility, number of companies, etc. These factors can determine the outlook investors have on these sectors, as well as their individual constituents. Some industries attract a lot of buzz from investors, as there are plenty of novel solutions presented, which generates talks about new billion-dollar, or millionaire-maker stocks.
Biotechnology is an industry that is focused on the testing, development, and commercialization of various health treatments and procedures. This sparks a lot of discussions any time a new drug or therapeutic treatment is released to the broader market - sending the stock of that company soaring. This makes biotech stocks exceedingly volatile and many instances have occurred where a company turns from a penny stock to one of the top performers of the year. Conversely, hundreds of biotech stocks are sent higher on promising news releases, only to then crash back down again.
There are several key factors to consider when choosing biotech stocks and the sector is best suited for investors with higher risk tolerance.
Biotechnology is a broader term used to describe the industry engaged in using natural processes for industrial applications. Generally, the biotech industry is concerned with solutions regarding human and animal health, nutrition, wellness, etc.
Some notable biotechnology breakthroughs of the past decades include:
Biotech is one of the most closely-watched industries on the stock market, due to its sheer amount of potential for market-beating returns. However, this potential comes at the cost of volatility. Many biotech stocks listed on an exchange do not even generate any revenue and are using the cash from private funding rounds to sustain their research.
Much of the success of biotechnology stocks relies on the relevant regulatory bodies that scrutinize their research and proposed solutions. Most biotech companies generate very little revenue until they go through the three-step drug testing process to make their solutions commercially available to the public. Public health is a topic policymakers take very seriously, which heightens the risk of failure for the hundreds of biotech companies listed on exchanges around the world.
Investing in biotech stocks comes with its unique sets of advantages and disadvantages. The biotech industry is different from most other sectors of the economy and knowing these differences can help investors better navigate the market.
The most important aspect to consider when investing in biotechnology stocks is the clinical trial. Clinical trials are three-step programs developed by regulatory bodies to test the effectiveness and viability of a drug/treatment before it can be made available to the public.
Clinical trials are very stringent and companies have very little margin for error, which increases the risk of failure and affects stock prices negatively.
The three steps of a clinical trial are:
The entire cycle of pre-clinical and clinical testing stages can be highly risky for investors, as they are hyper-focused on the results of trials which can determine the future viability of the treatment, which is meant to bring revenues to the company.
The completion times for each stage can vary greatly depending on the available data, the complexity of the treatment, and the required sample size for the treatment in question.
A commonly used phrase in the biotech investor community is ‘catalyst’. A catalyst is a major turning point that can decide the outcome of an investment. For example, any of the three regulatory stages, as well as their results are major catalysts for biotech stocks and can either send the stock soaring or crashing down.
As most biotech companies do not have solid revenue streams, investors do not have the requirement to scrutinize their financial statements all that often, However, one important factor to keep track of is the “cash burn rate”, which shows just how quickly the company utilizes its cash reserves and how long these reserves could last if the company maintains the current spending trajectory.
Keeping track of biotech catalysts can be a difficult task, but there are plenty of online analytical businesses that provide tailored biotech reports in exchange for a fixed subscription.
Investing in individual biotech stocks can be highly risky, which may turn some investors away from the industry altogether. However, this need not be the case. Biotech ETFs are a great way for investors that are bullish on the industry to gain exposure and invest in diversified biotech companies. Some notable biotech ETFs to watch in 2023 include:
These ETFs are diversified across hundreds of biotech stocks, ranging from well-established corporations, to pre-revenue biotech startups. Biotech ETFs are a more accessible way of investing in biotech, as investors can view the individual components of the fund to decide whether to invest or not. Diversification also lowers the relative volatility of the investment, which is essential for most long-term investors.
"There's never been a better moment in time where you've seen this thing be more relevant, when we're coming off the Covid-19 pandemic and we've seen some of the technology specifically on the MRNA side, s biotech companies like Moderna, like BioNTech have raced to complete a successful vaccination, I think it's really clear how this theme [!of!] is not only relevant but is attracting more and more investors" - Rene Reyna
It is important to note that hundreds of biotech companies listed on stock exchanges are quite small. The market capitalization of these stocks may range from as low as $5 million to $500 million. These stocks make up the bulk of biotech listings and can be notoriously volatile and sensitive to important new developments. It is also easier to manipulate the price of a micro-cap stock than it would be in the case of an industry giant, such as Moderna (NASDAQ:MRNA), whose market capitalization exceeds $55 billion.
Understanding the dynamics of micro-cap biotech stocks is incredibly important when choosing what biotech stocks to invest in, as there are numerous cases where a stock that once traded in the $100 range, is now on the verge of being delisted from the exchange.
These tiny biotech stocks attract thousands of investors with each new press release, as positive test results, or other significant developments can surge their prices to all-time highs.
Biotech stocks are notoriously difficult to analyze and evaluate. Typically, each new drug or treatment has to go through rigorous testing and comply with numerous regulations before becoming available to the public, which greatly increases the risk of failure.
As an industry that is inextricably linked with science, the entire analysis of biotech stocks can be very challenging for someone who does not hold a degree in the relevant field. The importance of some news developments surrounding biotech companies can also be easily overblown, due to the sheer amount of interest from the investing community.
Biotechnology stocks generate a lot of buzz anytime they release some significant news to the public, and investors flock to act on the news as fast as possible. However, deciphering the meaning and significance behind each new report can be very difficult for an untrained professional. Biotech news releases often include a lot of information that is riddled with terminology specific to that field. The average investor is unlikely to have extensive knowledge regarding specific diseases and conditions, their symptoms, available drugs and treatment, their side effects, etc. Often, the drugs/treatments developed by biotech companies might not say much to the average investor. This is especially true for some experimental treatments that provide novel solutions to existing conditions. While investors may identify whether a report brings positive or negative news, digging deeper and finding the true significance behind each new development can be a major challenge.
Investors who cannot fully grasp the significance behind individual news reports released by biotech companies, tend to place their trust in analysts. Major investment banks employ teams of analysts that have relevant experience working in specific fields, including biotech. However, while these analysts stand a better chance of understanding the viability of new biotech developments, investment banks may induce an overly optimistic attitude into the market and send share prices soaring to unreasonable levels. Corrections can quickly follow suit - sending the stock price crashing down again. Another issue with analyst coverages is the degree of bias which is difficult to measure, as both buy-side and sell-side analysts may benefit from manipulating the stock prices of small biotech companies.
Yes. Most biotech companies tend to be small and some are even pre-revenue startups without a finished product. This makes biotech stocks very volatile and prone to sudden price changes.
Much of the success of biotechnology companies depends on the results of pre-clinical and clinical trials, where their drugs and treatments undergo rigorous testing to decide their effectiveness in achieving predefined objectives. When the trial results are negative, the risk of failure for biotech companies increases dramatically.
Some of the most important biotech catalysts to look out for are the three stages of trials and the results of each of them. The preclinical stage, or Stage 1, is the riskier stage where hundreds of companies may fail.