Investing in biotechnology stocks is a high-risk venture that can come with great rewards. Most biotechnology stocks trade on great promise and potential alone, as their books and financial statements usually have very little content to sway investors. To get a better idea of the value of one of these stocks, it is important to understand what products the biotech is looking to produce and when the products are expected to reach the marketplace.
Biotechnology Stocks and Pipelines
A biotechnology company usually has a product pipeline, and finding a company with a good pipeline is an essential first step in this sector. A pipeline is a lineup of products being developed at various stages of development. Products usually go through a rigorous Food and Drug Administration (FDA) approval process starting with preclinical trials and proceeding to three-phase trials to test the safety and effectiveness of each product. Companies with diverse product pipelines can offer more value to investors, but typically come with more costs associated with research and development as well as trials.
Volatility of Stock Prices
Positive events, like earning FDA approval for a product, often double a company's share price in a single day. On the other hand, a rejection by the FDA can reduce a company’s market cap significantly, frequently cutting a biotechnology company's valuation by more than half in a single day. On the other hand, good news can lead to an inflated valuation that is unlikely to last. Many experienced biotechnology investors will buy on the dip when prices drop if they have a strong belief in the company's product pipeline. Price movement is common because of these issues, and certainly is a risk factor in this sector.
Funding Product Development
The FDA approved 27 drugs in 2013 after a 15-year high of 39 drugs in 2012. Considering there are over 900 drugs in development, you can assume that negative events will usually happen more often than not to biotechnology companies. A company that has a strong cash position and a low cash burn rate will often be able to advance its products through any hurdles experienced in development. The income statement is a tool for determining how much money a biotechnology company is spending each quarter (i.e., a company’s burn rate), while the balance sheet will show how much cash is left to continue operations.
Progress Updates and Analyst Views
Poor performance and analyst downgrades can also wreak havoc on biotech stocks. If product-trial results are delayed or the company provides insignificant updates, the validity of its pipeline can come under question. This will cause many investors to panic and the company's valuation to fall into a steep drop. Analysts that cover the stock you have interest in might one day downgrade it based on issues with reported performance of trials or financial shortcomings. An analyst upgrade can help create a buying frenzy and jump in valuation in a single day of trading.
Craig Keolanui is a small business entrepreneur with more than 23 years of experience owning and operating small businesses in the restaurant, business services and retail industries. He works as a small business consultant assisting with finance, marketing, planning and business writing projects and requirements.