It’s pretty difficult to generate market-beating returns when you’re waving pompoms.

Put another way, investors must remove emotions when making decisions about buying, selling, and allocating positions within their portfolios. That certainly isn’t easy — we’re emotional beings! Nonetheless, developing objective frameworks for finding early-stage drug developers and synthetic biology companies has helped me to make the most progress as an investor and led to me becoming part of the team at 7investing. The same frameworks can be leaned on to know when it might be time to sell.

When do you sell an early-stage biotech?

I only own drug developers that meet the three criteria of my discovery framework:

• Technology platforms spread risk throughout the pipeline and across therapeutic areas. This helps to insulate investors against any single failure.

• Addressing pain points is important for any business, but it helps emerging drug developers to attract deep-pocketed partners (de-risking clinical development) and create more convenient treatments for patients (de-risking commercial development).

• Durable advantages allow drug developers to win within the competitive landscape and maintain commercial success. These could be anything from superior technology to efficient commercial infrastructure to attracting and retaining talent.

As the first point suggests, a clinical trial that fails or delivers mixed results is rarely a reason to sell. The companies I own and recommend at 7investing aren’t one-trick ponies — one has over 35 programs! Failure is also part of drug development. From 2011 to 2020, only 7.9% of all drugs that entered clinical trials reached the market. If investors sold every time a drug failed, then they wouldn’t end up owning any drug developers!

That said, an early failure or a string of failures for an emerging technology platform could provoke investors to revisit their thesis. Is the company’s approach or development hypothesis misguided? How does it rank now within the competitive landscape?

Drug candidates that deliver successful but underwhelming results might also lead to some soul-searching, especially when multiple drug candidates from the same technology platform turn in a mediocre performance. Will the drug candidate still address the desired pain points as efficiently? Are the company’s durable advantages proving more fragile than originally thought? This is when knowledge of the technical details and competitive landscape become incredibly valuable.

Be a shareholder, not a cheerleader

These questions aren’t always easy to answer, but the most important thing is to remain objective. Some pitfalls I made as a less experienced, more naive investor:

• Develop a thesis. Most investors don’t develop a thesis, which means they don’t have a deep understanding of why they own a business. This can be devastating when the fast pace of innovation in biotech is taken into account. Good technology doesn’t mean a drug candidate will enjoy commercial success.
• Don’t get greedy. If you’re only focused on the opportunities and not the challenges a drug developer might face, then you’re probably letting emotions get the best of you. Troubled drug developers rarely turn it around.
• Put down the pompoms. If you allow management to make too many excuses or put a spin on terrible clinical trial results, then you’re exposing your portfolio to too much risk. It’s your money.
• Seek external information. If you only rely on information provided by the company (example: investor presentations) or industry publications (example: a conference platform), then you’re probably not consuming enough objective information. You want information, not confirmation.
• Read things you think you’ll disagree with. It might not change your mind, but you’ll absorb different viewpoints and learn dissenting arguments. You’re a shareholder in a company, not a cult.

My style of investing inherently requires more patience (“accumulate and wait”) and forces a long-term mindset. As such, investors must have realistic expectations when they begin building a position in these types of companies, even if they’re only a small part of a portfolio.

Is an early-stage drug developer going to crush the market in the next 12 months or 24 months? If there aren’t any major de-risking events in that timeframe, then there’s really no reason to expect much outperformance. But if and when the thesis plays out over multiple years and pipeline programs, then the performance differential to the S&P 500 won’t even be close.

The key is knowing when to let your thesis breathe and when to exit a position to redistribute your hard-earned money to a higher conviction investment. The brief points outlined above should help investors to think objectively when making difficult decisions.

Our advisors recently took a closer look at several of our previous 7investing recommendations, and we found a few things we didn’t love. Click here if you’d like to see the specific red flags that we have identified.

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