Choosing Biotech Stocks

Investing in biotechnology can be a risky business. The following list outlines some suggested criteria to consider when choosing which biotech stocks to buy.

HOT Areas of Research

Woman looking into microscope with monitor in background
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Watch for companies researching areas such as cancer, AIDS, diabetes, heart disease, neurological diseases, immunological diseases, viral infections and tissue regeneration, where there is a high degree of incidence in the population. Success in these areas will ensure the company a ​faster return on their investment in R&D and licensing efforts. An alternative is to invest in a niche company with an orphan drug that, if successful, is protected from competition for several years.

Collaborative Support

A strong network of collaborative support is an indication that a company is financially and logistically stable. A small company, despite having good ideas, might find it difficult to go it alone, but can benefit immensely from the backing of one or more larger corporations. Several sponsors provide added security since the withdrawal of support from one collaborator might result from missed milestones, strategic differences or a general loss of interest in a project.

Ample Long-Term Funds

Some financial advisors say to select companies with at least 2 years of cash reserve. It takes many years to license a product, however, and even longer to recoup the costs of developing it. There are many different options for financing a startup, so investigate new companies carefully. It's also important to consider where more established companies get their funding, and whether there is potential for more if needed. For publicly owned companies, you must judge whether they have excessively diluted their shares. Companies with private financing, milestone payments and sale of debt securities (secured and/or convertible) have more potential for stability than those without any of these sources.

Low Debt

In addition to looking for companies with sufficient funding to support their future research efforts and necessary R&D to get a product to market, it is important to watch for those that won't be spending all of that funding paying off debts. Look for a company that hasn't already taken out excessive loans, from banks or private investors, to get started.

Pipelines With Potential

Look for ​companies with pipelines consisting of more than one product. Those with at least 2 products in clinical trials are safer than those with only one good idea. If one product fails, there's always the second to fall back on. A company with several products in various stages of development might be spread too thin, although it also might have multiple routes to success.

Market-Ready Products

Look for companies with products that are nearing the end of the R&D/ FDA approval process and can be realistically expected to hit the market sooner than later. Of course, by this stage, success is still not guaranteed but if the bulk of stringent testing is completed there is a higher likelihood that you will soon see some return on your investment. It's a good idea to watch for new drugs that have reached the stage of clinical testing on human test subjects since animal models are not always a reliable indicator of efficacy and safety. Tests on cell lines may reveal even less about a candidate drug.

Rebound Potential

Previously highly valued stock might be found at a lower price if the company has recently gone through a rough patch and experienced some difficulties. The stock market is often hard on companies that hit a temporary glitch, overreacting to any news, whether it is good or bad. This is particularly true for the biotech industry. Prices might drop dramatically as a result of slightly bad news causing public perception to suffer and investors to panic. But, although the company once had promise, a low share price isn't the only criteria you should be looking for. Before buying up these cheap stocks, be certain that the glitch is something that can be fixed.

Good Management

It's important that a biotech company is being managed by knowledgeable, business-savvy entrepreneurs, but companies whose managers also have a scientific background or research experience (a Ph.D. or MD) are also recommended by seasoned investors. One of the benefits of obtaining a doctorate, that these individuals have, is the technical knowledge to understand the business they are in and fully grasp the ramifications of research data as it becomes available. Using that understanding, they are more likely to make sensible decisions about how company resources are allocated, choosing the best candidate drugs and research strategies.