How to identify a promising biotech company

Filed under: Biotech ETF

A biotechnology investment can be financially rewarding and mentally stimulating, besides being a lot of fun. However, because of the intrinsic risk as well as the complexity of the business, it is not easy to find a promising investment. There is no other industry whether success is so critically dependent on regulatory approval at every stage of the long drawn-out product development process. The goal of the regulators is to achieve 100% security and efficacy wherever possible.

What makes the identification process even more difficult is that less than 0.01% of biotechnology companies are successful. Even the successful ones can take 10 or 12 years to show that they have been successful. Because many of these companies do not have any revenues were speaking of or any kind of track record, they are extremely difficult to value. You cannot use discounted cash flows and it is extremely difficult to predict the chances of success even for a company that has a drug in the last stages of testing and evaluation.

There are some existing medium and large capitalization companies that have some kind of a track record of success and still offer profitable investing opportunities but they are far and few between. You need to have a long-term investing approach in selecting biotech companies for investment but prices tend to be influenced heavily by the flow of news. Good news can see large appreciations while disappointing news can see equally large losses. Here are some benchmarks for identifying potentially promising candidates.

Platform technology refers to the in-house scientific knowledge and expertise of a biotech company that enables it to distance itself from the pack. This is critical to successful product development as is the existence of several drugs in the development pipeline so that, even if one drug fails, the company has other drugs as a fallback. The most vulnerable companies are the companies that are dependent on the success of one single project. Another investing approach is to look for biotech companies that specialize in remedies a single disease or a single niche such as diabetes. The market will however tend to evaluate the company on the success of its most advanced product development.

From an investing point of view, the most promising candidate would have established partnerships or strategic alliances at the early stages of product development. As a measure of by ensuring survival, biotech companies tend to have several partnerships or alliances with larger companies either for research or for marketing. These partnerships provide both the product endorsement required for success as well as financial support in some cases.

In any event, you are better off with a biotech ETF investment rather than the significantly riskier single stock approach especially if you are a small investor. The ETF will give you an instant diversification as well as the comfort of a portfolio of investments which will cushion losses in the case of individual components. It is true that you are sacrificing the potentially high returns that a single biotech stock can provide but you can limit your risk with an ETF investment and thus minimize your potential investment losses.

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