Biotech stocks are off to a scorching start in 2019, with $XBI, a leading exchange traded fund in the space, up 26% since the beginning of 2019. Some big names have doubled in just three months as merger mania has exploded on the scene. Opportunity abounds, but here are some tips to make sure that you don’t fly too close to the sun…
1. There is gold out there!! Somewhere.
One reason why there is a lot of excitement in the air is because we really do see a lot of new technologies emerging that could transform medicine forever. A lot of these discoveries are being published in reliable journals, with transparent data, by reputable scientists. However, from an investment perspective, it’s important to remember that they won’t all pan out, and even if they do become viable medical technologies, with time, only a few will dominate. It helps to consider the Internet Craze of the late 90’s.
Even in its infancy, it was obvious that the internet was going to change everything. But, in hindsight, what was NOT obvious was exactly HOW it would change everything, WHEN it would change everything, and WHO would come out winners. Anyone remember when AOL was a big deal and the Google boys were a bunch of scrawny nerds in a garage somewhere?
The lesson of history is that even if you pick a stock with a winning technology, you may still not have picked the winning executive team. Don’t buy just on technology; research the top few execs at each company, if you wouldn’t want them managing $10 of your money, then don’t let them manage $10,000 of your money either.
2. Tomorrow’s biggest winners may be getting the least hype today.
In the era of the Unicorn, more and more biotechs coming to the IPO scene have already raised, and burned through, many millions of dollars. The day they first sell one share of stock to the public, Wall Street may already be valuing them at 2 or 3 Billion dollars, even if the most they have accomplished is some cool tricks with mice.
It may well be that a few of these billion dollar babies will one day justify their rather expensive birth into the world of big business. But most won’t. The Venture Capitalist, The Investment Banker, the Gushing Analyst on CNBC…if you think about it carefully, they may all have short term agendas that could leave you holding the bag in a few years if those neat tricks with mice never quite turn out to be lucrative cures for humans.
The old expression still holds true, whether you are picking through a garage sale or hoping to cure cancer, “You don’t make money when you sell, you make money when you buy.”
Some IPO’s rocket out of the gate only to fade a few weeks later when the sugar high of media adulation tapers off. Other IPO’s just never quite capture the news media’s imagination to begin with. These may be some of your best buys; even if the road to profitability is long and rocky, you will have bought into untested technology at a price that reflects the risk….
3. Don’t forget the Consolidators.
If you have been brave enough to scrutinize the financial statements of many young biotechs that garner media attention, you might have observed that they are barely companies at all in the traditional sense. In other words, many publicly traded biotechs today are little more than pools of capital that have been gathered to develop a certain scientific asset. While they have something to report on the “asset” side of the ledger, and certainly plenty of red ink on the “expenses” part of the ledger, the “revenue” part of the profit and loss statement is often as barren as a Siberian tundra in winter. How would a team of executives ever hope to make money without meaningful revenue coming in the door?
Very simple. The publicly traded company is a convenient vehicle to gather the necessary capital to develop an asset to a certain point when the whole company can be sold. A fair percentage of biotechs enter the IPO market today knowing that they will never sell a product or employ a sales force. They will prove a concept, perhaps gain an FDA approval, and then sell the whole thing to a larger company.
Somewhere in California I am sure there is a yacht club filled with ex scientists and execs who have managed to do just that, but it’s too risky a game for some investors. Depending on your personal risk tolerance, you might prefer to simply own shares in an established biotech, knowing that it will eventually absorb many tiny companies and commercialize the products that the formerly independent companies pioneered.
Examples of these kinds of “consolidator” enterprises are stocks like Gilead ($GLD) Amgen ($AMGN), and Biogen ($BIIB). On the pharmaceutical food chain, they are somewhat smaller and more nimble than lumbering Big Pharma Giants, but they still mostly thrive by commercializing products invented by others. These “consolidator” companies display many of the attributes that make traditional investors feel more comfortable; steady revenue, predictable cash flow, reasonable balance sheets. The thrilling, yet, immature, technology outfits that debut with no sales will often wind up a division of these kinds of organizations.
4. What Goes Up…
Have you ever met someone who used to be rich? I can tell you, it’s not a lot of fun, not for them, or for anyone around them. I have met quite a few former stock market geniuses over the years who mistook a raging bull market for personal skill, and wound up losing just as much as they ever made. Many don’t ever quite recover, and resent going to work every day to scratch out a living.
Don’t be that guy. Recognize that biotech investing is inherently risky. Use margin credit with great caution, if at all. Don’t put anything into a biotech IPO that you couldn’t afford to lose. Keep some money in less risky assets; that way any random market swoon won’t force you to liquidate against your will. Most of all, learn to really scrutinize all available information about what you are buying. If you want to gamble without thinking, go to Vegas. If you want to gamble with the odds tilted in your favor, study up on biotech.
Biotech stocks are the Ferraris of the healthcare world. There is nothing like the thrill of pushing the pedal to the metal and feeling that baby fly. But for goodness sake, put on your seatbelt and keep an eye on the road…
So far, 2019 has been an epic ride for us biotech investors. With both technology and demographics on our side, the good times could continue for quite a while. Following the four tips above will minimize your hangover whenever the party ends…