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How to Invest in Biotechnology

7investing's resident biotech PhD shares some valuable lessons about what to look for when investing in this space.

October 27, 2022

Investing is challenging. There are all sorts of things to consider: the company, the industry, the macroeconomic climate, and how the market responds to each variable. Great companies are often overlooked and bad companies might be hyped up.

As investors, we need to be sure of ourselves and our thesis. We need to come up with a plan and stick with it. 

Now suppose you want to invest in the health care industry, specifically biotechnology and the pharmaceutical industry. Here, things get even more challenging. While we might be able to measure a company’s position in the industry by revenue, customers, growth over time, or how well or poorly a company is being run, when you are investing in biotechnology and drug development companies, you are dealing with a variable you have little control over…biology.

Science is hard. Even the brightest minds may misjudge the complexities of biology. What decades of research may point to, can quickly unravel when you try to alter something because a backup system gets triggered unexpectedly. This complexity is one of the things that, to me, makes biology so beautiful. It also makes it hard to predict and control.

For drugs, the pathway from idea to market is complex and highly regulated. First you need to understand the basic biology around a disease enough to hypothesize how manipulating one molecule or another might change its course. Once you identify your target, you need to figure out how you want to change it and then design a “drug candidate” to manipulate it. The candidate needs to be able to get to the target, bind the target, cause the right response at the correct level and duration, without triggering an unforeseen response. Then you need to put the candidate in an animal model (non-human and human) to see how the candidate behaves in the complete system and make sure the drug candidate is safe and effective.

An image of a scientist holding test tube and analyzing data DNA

I’m not going into all the fine detail on any one of these steps, both because it’s out of scope and to help preserve your sanity (although I’m always happy to chat about it in our 7investing community forum). The point is to say that there are a lot of additional conditions that biotech companies need to consider that go beyond what an investor might be prepared or able to evaluate when looking at a company for potential investment.

The size of the market is not as important to me as we are moving away from “blockbuster” drugs and moving towards more personalized medicine.

As Merck (NYSE: MRK) learned with Vioxx, one drug fits all medicines can prove to be detrimental. As we have the science and tools to understand diseases better and target disease molecules more specifically, drug companies can make specific drugs to work in specific populations. While the potential market size may decrease as a result, the likelihood of success through the regulatory processes increases. There are still unknowns, but there is also more supportive data to help guide clinical trials to better outcomes.

As a person who enjoys some level of control, it is hard for me to invest in this industry. However I believe it is an important industry and needs investment in order to be able to have the opportunity to bring new medicines to market to help cure what ails us. I don’t take this level of risk lightly, especially when I am making a recommendation that could impact other people. I am fortunate to understand the science as well as all of the complexities that must be studied and the regulations that guide them. 

These are some things that I use when evaluating biotechnology and drug development companies:

  • Publications and discussing data at conferences. Even if you don’t understand the science and the data being presented, that the data is being presented publicly typically suggests that the drug is showing beneficial results (that the scientific community only publishes positive data is a different topic). Scientists by training share information. In the pharmaceutical industry, drug candidates are often patented as soon as they show some viability, so publishing data is not much of a threat to the business (as may be the case in other industries.) Typically a company will list news of a publication or presentation at a conference on the News and/or Events page of their website. If a company does not share data, that is usually a red flag for me indicating that something is going wrong with the science.
  • Clinical trials. Drug candidates have to go through the FDA regulatory process in order to be approved for market. Fortunately for investors, the US National Library of Medicine operates, a database of clinical trials at various stages. One can do an advanced search to look for a company of interest (I look at both Sponsor/Collaborator and Sponsor (Lead)) to make sure what the company is saying about progressing a drug candidate through the pipeline is actually taking place. The site indicates the status of a clinical trial and may even present some preliminary data. It will also show where a trial is being conducted and who is running the trial as well as the different phases. A company may not even mention clinical trials on its Investor Relations page, so this is a good way to gain more insights into the company as well.
  • A company’s pipeline. A drug candidate making its way through the development process often hits some snags along the way. It is possible that a drug that behaved well in animal models doesn’t do well in humans, for example. Even if the science seems sound, biology is complex and sometimes things don’t work the way they should. It is good for companies to have multiple drug candidates in their pipeline so they don’t need to start from scratch should a candidate fail to proceed. The company should also not have too many candidates to distract from the focus and spread out resources. When I look at a company’s pipeline, I like to see a nice progression of candidates, such as a couple candidates in each phase of the drug development process. The candidates may be the same or similar molecule for different indications or could be different molecular entities, depending on the focus of the company. To me, having a broader pipeline suggests that the company is focusing on growth while also creating a contingency plan in case a candidate fails.

Investing in the pharmaceutical and biotech industries is hard, especially when it’s outside the scope of your training. But it can be done with less risk by understanding the additional items that companies operating in this industry need to consider. These are the things I think about, but there are other variables to consider such as the sales process, CMS reimbursement, and how regulations may change over time. It may be challenging, but it can also pay off, especially when investing in a company means that a drug candidate makes it to market and can help someone who needs it. Investors can do well and do good too.

More content about biotech from 7investing lead advisor Dana Abramovitz:

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