What are Biotech Stocks and How to Invest in Them?

Updated 4 weeks ago by Osaemezu Ogwu · 10 min read
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Photo: Depositphotos
Photo: Depositphotos

Here we present an introductory guide to biotech stocks, an exciting, lucrative, scary and risky investment vehicle, and the best way to invest in them. 

At a time when the world economy is somewhat in a recession due to the disastrous COVID-19 pandemic, the surest way for smart investors to survive these crazy times is to diversify their investment portfolios as much as they can in order to cushion the effects of the market crash. According to Barron’s report, Biotech stocks have always weathered previous economic storms, as well as the current recession, better than stocks in other sectors, including the S&P 500.

What are Biotech Stocks?

In simple terms, biotechnology firms are companies within the healthcare, technology, and agriculture ecosystems that dig deep into nature and expertly make use of living organisms in the creation of medicines and health products. In other words, the primary objective of biotech companies is to tackle problems through complex research and formulation of highly functional products based on biologic.

For instance, when there is a disease outbreak such as the ongoing coronavirus epidemic, these biotech firms, and their researchers carry out thorough research to come up with a cure for the COVID-19 virus.

It’s pertinent to note that oftentimes, biotech firms spend months or even years to develop and launch a product. This is simply due to the fact that they have a lengthy, complex, and quite rigorous product development lead time (the time taken by a company to develop a new product).

It takes an average of 12 to 24 months for a new medical product to get developed, plus an additional three to six months for it to get the seal of approval from the relevant regulators before it finally hits the market.

Biotech Stocks vs Pharmaceutical Stocks

Most times, people mix up biotechnology with the pharmaceutical industry. However, we’ll let you know the basic differences between the two.

The key distinguishing factor between biotech or biopharmaceuticals from traditional pharmaceuticals is that the former applies the knowledge of biology in manipulating or changing the functions of a living cell or organism to make it behave in a particular way, making it more predictable, controllable and beneficial to the health.

In other words, biotech firms leverage advanced knowledge in the genetics of living organisms and research to formulate medicines and products for human ailments and health conditions. It’s worth noting that apart from developing human health products with biology and genetic technology, some biotech firms also apply biotech and genetic technology in several other areas including crop manipulation.

On the other hand, pharmaceutical industries basically manipulate chemicals and in some cases plants, to create medicines that manage or totally cure diseases. Pharmaceutical companies also produce vitamins, health products and feeds for animals, and more.

Depending on how large a pharmaceutical firm is, it may carry out in-house research to come up with new drugs or try to license drugs with great potential from other pharma, academia, or biotech firms.

In essence, for a stock to be considered a biotech stock, the company behind it must be entirely dependent on living organisms and genetic technology for the creation of their product. Also, the company must be generating most of its income from its bioproducts.

The biotechnology ecosystem surpassed the $417 billion mark in 2018 and it is estimated to achieve a compound annual growth rate (CAGR) of 9.9 percent and rise to $775 billion by 2025. For context, as of March 2020, the top 10 biotechnology firms in the world include Novo Nordisk, Regeneron Pharmaceuticals, Biomarin Pharmaceuticals, Incyte Corp, and Alexion Pharmaceuticals among others.

The pharmaceutical ecosystem achieved exponential growth in 2018, reaching a massive $1.11 trillion and it is estimated that the industry will hit the $1.43 trillion mark in 2020, as demands for drugs continue to rise. For context, the top 10 pharmaceutical firms include Bristol-Myers Squibb (BMS), GlaxoSmithKline (GSK), Amgen, and Novartis, among others.

As it concerns investors, the difference between biotech and pharmaceutical stocks is more obvious because:

  • Biotechnology firms require far more operating costs upfront and in most cases, it takes them several years to develop a new medicine or product.
  • Pharmaceutical firms, on the other hand, generate regular income from their products in the market, plus a steady flow of research and development for new products or improving existing ones.

Specific Risks

While investing in the biotech industry can be quite exciting and highly profitable, like every other sector of the economy worth investing in, there are also risks involved in the biotech industry, as such one has to pay attention to his/her risk tolerance before pumping in money into any biotech stock.

Specifically, biotech stocks have several risks associated with them including the risk of regulatory disapproval, clinical failure of the product, poor commercial performance, poor financing, and patent expiration.

Clinical Failure

Despite the fact that biotech firms spend several years developing their products, there is still no guarantee that the finished medicine will make it past the three phases of clinical trials usually carried out to ascertain the efficacy and safety of the medicine.

The drug testing process begins with preclinical tests carried out in vitro, using test tubes, culture dishes, and other ways that don’t involve humans or animals. Also, preclinical tests can be done using the in vivo method, involving lab rats or other animals. Interestingly, when a drug achieves positive results during preclinical testing, the biotech firm in charge of the product can go ahead to apply for regulatory approval from the U.S. Food and Drug Administration (FDA) or the European Medicines Agency, before moving ahead to Phase 1 of the clinical study of the product.

Note especially that purchasing the stocks of biotech companies whose experimental drugs are yet to scale the preclinical stage is a very risky endeavor because a good number of these drugs may never move on from the preclinical testing stage to clinical testing.

The clinical testing of drugs comes in three phases. In Phase 1, the biotech firm tries to find out the safety and efficacy of the experimental drug, find out its possible side effects, and know the best dosage range of the medicine. Sadly, according to the Biotechnology Innovation Organization (BIO), the largest nonprofit trade organization in the world representing the biotechnology industry, a whopping 37 percent of drugs examined in Phase 1 clinical studies do not achieve positive results.

Once a drug or bioproduct passes phase1 clinical studies, it advances to phase 2 clinical studies, where its efficacy is further tested and appropriate dosage levels determined. According to BIO, about 70 percent of drugs fail to make it past Phase 2 clinical testing. The successful ones, however, advance to phase 3 clinical studies where extensive clinical trials are carried out to get sufficient statistical data to prove the safety and efficacy of the product.

Roughly 42 percent of drugs fail during phase 3 clinical testing. In total, just 11 percent of experimental medicines that are clinically tested scale through the three phases of clinical studies and secure approval from regulators.

Regulatory Disapproval Risk

Interestingly, even after making it past the numerous testing phases, a drug may still not get a green light from regulators. About 15 percent of medicines submitted to the FDA for approval is rejected and in some cases, the biotech firm may carry out more clinical studies in a bid to persuade the regulators to approve the product. According to eyeforpharma, the approval rate for new drugs varies for each medical specialty. Oncology drugs, for instance, have a 72 percent approval rate, while pulmonology and allergy medicines have a 31 percent approval rate.

Poor Commercial Performance

Even though a new bioproduct makes it past the phases of clinical testing and the strict approval processes of regulatory agencies, the creators still need to put in significant efforts to market the product in order for it to achieve commercial success.

Specifically, biotech firms must convince and persuade the relevant insurance firms, government healthcare initiatives, and others to pay for the new medicine.

In the United States, for example, biotech firms often forge alliances with major insurers, Medicare and Medicaid, as well as pharmacy benefit entities, in a bid to provide coverage for the product.

That’s not all, in order to ensure their products have the upper hand in the market, biotechs must engage the services of professional marketers and build competent sales teams that will promote the new product to prescribers. These firms also need to try as much as possible to market the new product directly to users via various channels including online, print, and television ads.

Patent Expiration

As stated earlier, it takes several years of research, development, and hard work for biotechs to come up with a new product. Due to this lengthy product development lead time, some biotech products may become obsolete even before it hits the market.

Though biotechs usually enjoy a 12-year exclusivity period plus a patent expiration period of 20 years after the filing date for their new products, which makes it almost impossible for competitors to launch a biosimilar product while the protection lasts. However, when these protections expire, rival firms can legally launch similar or an even better product than the existing one and this causes a significant decline in sales for the existing biotech product.

Poor Financing

As stated earlier, biotech firms carry out extensive research and development while trying to create a new product and these endeavors consume huge amounts of money. As such, before purchasing the stock of any biotech firm, it’s important to check out the source of funding of the firm.

Some biotechs offer their stocks to interested holders in exchange for cash, some get funding from large venture capital firms, while some others may ink partnership deals with leading pharmaceutical companies to get funds.

When to Invest in Biotech Stocks?

After considering the major risks in investing in biotech stocks, the next thing to do is to know the best time to purchase the stock of a biotech company, to avoid making a decision that may not yield the best result.

Before pumping your hard-earned money into the stock of any biotech company, try to find out whether the company’s product has passed the entire phases of clinical testing and has already made it to the market. Also, it’s important to find out whether the biotech firm in charge of the stock is attracting interests and investments from top investors and larger firms, as this may be a great sign that the stock has huge potential.

That’s not all when a biotech company gets huge amounts of upfront payments for a product, it shows that big-name investors are highly confident that they’ll receive massive returns on their investment in the near future.

Where to Invest?

Just like the stocks of firms in other sectors of the global economy, biotech stocks can be purchased on exchanges including NASDAQ and the New York Stock Exchange (NYSE).

In conclusion, while the risks involved in the biotech industry are quite enormous, it also promises investors with good risk tolerance, great returns on investments. However, even at that, the best bet for the smart investor remains to diversify his/her investment portfolio across several sectors. This way, it becomes almost impossible for an investor to lose all his/her fortune when things go wrong in any particular sector.

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