There are several factors and parameters that the investors should consider before making any investment decisions. It is important to understand that these factors continuously will change since biotechnology is developing and new technologies appear every few months. Thus, any recommendations should have a specific and limited time line. Below we present the key factors related to biotechnology investing:
- Category of biotechnology drugs: It is important to evaluate the risk related to the drugs included in the R&D portfolio. For example, an antibody is an established technology that has been successfully used in the last few years, while on the other hand the use of RNA inhibitors (RNA interference products) have not been extensively used in the market and there is a higher risk related to these inhibitors.
- Drug pipeline: The investors should evaluate how long it will take for the lead drug to be approved from FDA and reach the market. Furthermore, a key factor is to examine if the drug pipeline is broad enough to provide security and balance the volatility between the different products.
- Patent Portfolio: The investor should valuate if the company holds gene patents that are highly risky and can be affected by US government decisions. Are there any ethical concerns related to the technology? In addition, the investors should examine when the patents are expiring. Also, the investors can easily search in the US patent office, to check if there is a company that holds a very similar patent or a patent related to the specific product.
- Biotech/pharma competition: The investors must examine how many competitors are working toward the same disease gene target and if any of the competitors is more advanced in the clinical trials stage. It is a red flag if a big pharmaceutical company develops a drug for the same disease gene target, since these companies have more resources to move faster and more efficient in this process.
- Biotech alliances: The investor should examine if the target company is currently collaborating with other major biotech companies that could add credibility and stability. On the other hand, if there are licensing agreements then the revenue derived from a drug will be smaller since the major company will own the majority of the profits.
- Biotech financials: The investors should evaluate the cash available in the biotechnology company related to its annual expenses and estimate the burn rate and the survival rate before it will reach profitability. Also, they should assess if the company is not profitable then how tolerable is its volatility. Furthermore, they should closely monitor if there are any warning signs from increasing trading volume during a downtrend.
- Biotech analyst opinions: Since the number of biotechnology companies is increasing, there will be also an increase in the number of biotech analysts in the next few years. The investor should consider how accurate the analyst’s previous predictions were. Furthermore, the investor should examine, if it is possible, any potential relationships between the analyst’s company and the biotechnology company.
- Biotech management team: It is essential that the company’s management team includes executives with high scientific knowledge proved by scientific publications, awards and invited lectures. Also, it is important that in the executive team there is balance between the business and scientific backgrounds. Finally, the management team should have a well-defined strategy and focus to develop new drugs on a specific disease or molecular mechanism.
Need for new valuation criteria in the biotech sector
There are several known metric to the investors that are very frequently used to valuate the financial profile of a business; however most of these methodologies are not applicable for biotechnology companies. For example, the very popular P/E ratio, measures the price of a stock relative to its company earnings, but this metric could not be applied in the majority of biotechnology companies which do not have any operating or profit margin and a P/E ratio. Thus, there is a great need to consider or develop new valuation metrics for biotechnology companies. There have been different efforts in the past to develop novel metric and formulas, however these formulas have not taken into consideration the unique aspects of the biotechnology sector. For example, the MC/RD ratio divides market capitalization with total R&D spending over the past 5 years. However, we know that all drugs in the R&D pipeline of a biotechnology company do not have equal value. This ratio is aiming to establish that a company justifies its stock price through spending enough money in its R&D pipeline. Since the early-stage biotechnology companies burn cash very fast, the investors should examine the cash available in the company in order to continue to fund operations for the next few years and identify how many years the company would need in order to bring a drug from its R&D portfolio to the market in order to start being profitable. Another potential good indicator for the investment community when valuating a biotechnology stock would be the identification of credible institutional and mutual fund holders in the finance industry. In conclusion, it is obvious that the biotechnology stocks are volatile, difficult to valuate and require specific technical and scientific knowledge. Thus, it is essential to develop novel valuation models and tools that will provide a long-term perspective for biotechnology investors.