Small and mid cap biotech stocks represent a stronghold of true speculative value in the current stock market. In the last few years biotech has been in the doldrums with investors only rewarding those companies that have passed phase three trials and gained FDA acceptance. Now the sector has a wide spread following and has become much more volatile.
For the most part, investors look at clinical trial performance before purchasing a biotech stock. Some notable exceptions occurred a few years ago when both Entremed and Biomira advanced on the release of what was old news reported in such a way as to lead the unsophisticated investor to think things were just breaking. Entremed went from $12 to $85 in one day and settled back in the high $20 range while Biomira soared from $3 to $17 settling back to $3. Many biotech stocks have experienced a similar momentum rush this year.
This type of momentum does in fact demonstrate what can happen when a biotech company with a hot product does pass FDA scrutiny. The market is finally ready to reward biotech companies that make major advances in important fields such as cancer. However it is evident that these price premiums will be sustained only by companies that either pass phase three trials with unequivocal results or by the important platform companies that have proven themselves in the market place.
Presently I believe that many of the platform technology companies such as the genomic, the proteonomic and the chip companies are overvalued while many companies with actual drugs in the pipeline remain attractive values. Some of these companies are in phase three trails with potentially important drugs representing possible markets of well over $1 billion a year. It should be noted that even with meticulous phase two studies many drugs that progress to phase three will fail.
The way to invest in biotech is to buy at the right price and to buy a basket of stocks that have potentially important drugs in late phase trials. It is also important to select companies that have more than one product under development. That way, if one drug fails, there are others that can still succeed. Investment worthy companies should have solid phase two studies and the financial resources or backing to fund the expensive phase three trials. Lastly, licensing and royalty agreements should be crafted in a manner that allow for rich rewards.
There is untapped value in the biotech world. Yes, it is speculative. But if you buy a $ 3-10 stock and the trial succeeds, your investment can easily increase many-fold. One key is to buy at the right price to protect your downside. A $3 stock can go to $30 or down to $1. With these sorts of odds you can lose on a substantial number of stocks and still come out way ahead.