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Biotech Investing in Tumultuous Markets (The Entry Point)

posted Oct 23, 2011, 6:09 PM by Bryce Istvan
The primary and most important drivers of a biotech's stock price are clinical trial results. The below, from the National Institute of Health's www.clinicaltrials.gov details each phase.

In Phase I trials, researchers test an experimental drug or treatment in a small group of people (20-80) for the first time to evaluate its safety, determine a safe dosage range, and identify side effects.
In Phase II trials, the experimental study drug or treatment is given to a larger group of people (100-300) to see if it is effective and to further evaluate its safety.
In Phase III trials, the experimental study drug or treatment is given to large groups of people (1,000-3,000) to confirm its effectiveness, monitor side effects, compare it to commonly used treatments, and collect information that will allow the experimental drug or treatment to be used safely.
As drugs progress in the trial process, as long as results are favorable, the chance of approval gets higher. Additionally, in the early stages, the risk of a bad result generally outweights the reward of a positive one. For example, drugs that show positive Phase I results have not yet shown efficacy, so knowing whether the drug will be effective is still unknown. However, if the drug kills people, the company is pretty much out of luck and likely to be one of the majority of biotechs that never make it. Phase II and III trials have much more positive risk/rewards because the reward is higher. Failure is just as costly because a drug that doesn't work, or doesn't work as well as existing drugs, isn't going to be approved. However, positive results put the company on the path to FDA approval. This article from thestreet.com details phase II trial investing which the author believes is the "sweet spot." http://www.thestreet.com/story/11081462/1/sweet-spot-in-biotech-investing.html
The question for investors is generally whether to invest before or after the results of trials are announced. For those more willing to take risks, investing before the annoucement has a much greater upside. Biotechs often jump 20%+ on positive phase 2 and 3 results. However, if you don't have the stomach for the 20%+ downside that poor results can lead to, investing after the results is a better bet. With any phase trial, downside risk is generally higher than upside because, if results are good there is still no guarantee of commercial success, but, if results are bad, any hope for the company (or at least the drug) is pretty much done for.
If you are more cautious, investing after positive results, especially phase 3 results, can still have a lot of upside over the long term. You won't get the quick pop, at least until the FDA approval, but will still participate in the long term success of the drug.
FDA approvals can be another big driver of stock prices. No matter how strong clinical results are, the FDA may still have questions. Make sure to stay on top of the process as they often involve long review processes and the FDA often requests additional information before approval is granted. All requests for additional information are made public, so make sure to read them. Watch out for safety and efficacy questions, which are much more likely to lead to a rejection than questions about statistical analysis, study procedures, and other less serious issues.
Once a drug has been approved, the last step is to get doctors to prescribe it. Prescription information is released by companies periodically. Prescriptions can vary dramatically depending on what the drug is used for, but companies and analysts generally release targets. Drugs not living up to sales expectations can be problematic, especially if it is due to competition and doctors sticking with previously approved drugs. Dendreon (DNDN) is a good example of this. They recieved approval for Provenge, a prostate cancer drug, but did not come close to meeting sales projections. The stock dropped from $35 to $11in a single day.
Generally, when it comes to getting into a startup biotech company, the risk is higher the earlier you get in, but so is the reward. Determine what your risk tolerance is and use that to guide your investment. Remember, the best way to protect your money is to diversify. Don't put all of your eggs in one basket. Instead, look for companies that are looking to treat a variety of different diseases in a variety of different ways. A basic rule of thumb is that for every 10 biotechs 9 fail, but the one that succeeds can pay for the other 9.