14 Jul Biotech Investing – Evaluating Risk!
The market for biotech stocks is on fire lately, with the 75 companies that are tracked in the NASDAQ Biotech Index up over 44 per cent, versus an 8 per cent gain for the Standard and Poor’s 500 Stock Index. Why is this happening, and are there sound business reasons behind the current run in biotech stock prices?
A large group of investors just plain believe these companies will completely change medicine, as we know it today. Given their undying belief medicine can be revolutionized by some of these companies, they are creating a community of Holy Grail believers. Many of these investors are hoping all ships in the harbor will rise with the tide, and in the very short term a lot will, but eventually business fundamentals like sales and real profits enter the picture, and those not cutting it will drop in value very dramatically.
History tells us caution is required. A few favorable press releases do not make for a profitable company in the long term. Of the twenty-five or so companies that have had stock run-ups in the double digits, almost 75 percent of them are not even profitable! Do your homework on these companies before jumping into the deep end of the pool!
Once a stock starts to take off like Genentech, the true believers jump on many biotech stocks because they flat out just don’t want to be left behind. The herd instinct in this market sector is really quite remarkable, and the theory of all ships rising with the tide can be foolhardy at best. Slow down and do your homework. Don’t rush to buy biotech stocks just because you don’t want to miss out on the next great thing!
I’m not trying to rain on anyone’s parade, merely suggesting caution before committing a large chunk of cash from your portfolio for biotech investing. Take time to really study this market segment yourself and find out who are the major players.. How much cash do they have in the bank to use for working capital? A high burn rate of cash can easily cause a good company with great ideas to fold – they run out of money before the new product can generate revenues or they just can’t get new funding for whatever reason.
Biotech investing is critical for new companies desperately trying to raise the huge amounts of cash necessary to keep their momentum going. Society benefits from their fantastic discoveries, and it’s a noble thing they are doing for all of us. But the race is full of companies that flamed out for a multitude of reasons, including not getting FDA approval, clinical trials look good initially, but over time prove unreliable, and the house of cards collapses. But if you hit it right, the rewards can also be very dramatic!
William Dollar is a Senior Contributing Editor for the Wisconsin Technology Network, and has his own consulting company at www.billdollar.com. You can also contact him at firstname.lastname@example.org.