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Biotech Stocks and Why Should You Buy Them?

Anyone who have been paying attention to what Warren Buffett’s Berkshire Hathaway has been doing lately, they know Buffett have made some thought-provoking moves in the stock market. They have been recently come out and made big investments in the Biotech as well as pharma stocks. Biotech stocks have surged in interest with some of them growing more than 3000% value in just few months. We know the reason behind this, right? Of course Covid-19.  Before going into details, first we will have a look into the basics.

If you do a small research on what Biotechnology have contributed to us, you will get to know how powerful it is. We are familiar with successful genetic modification of crops, which obviously was a massive success. But its old news now! So far we were using Biotechnology to improve our way of living and efficiency, but the current Covid-19 situations have made biotechnology and its contributions inevitable. In other words, when we make these kind of things, we look to biology – Biotechnology. This has let a lot of investors including Warren Buffett to put their money on biotech stocks.

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What are Biotech Stocks?

Biotech stocks are publicly traded companies that develop pharmaceutical drugs used in the treatment of disease. Some of the best Biotech stocks are Gilead sciences, MERCK, AMGEN, BIOGEN, Johnson and Johnson. Given below is a graph showing the Growth of Biotech Stocks vs Average S&P 500s Growth (Top 500 Public Stocks) in last 10 years.

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Reasons Why We Should Invest In Biotech Stocks
  • World population is aging: The population is increasing and by 2050, nearly 15% of human population will be above age 65. As the population is aging, demand for vaccines and medicines will obviously increase. Investing in field where there is a need and at the same time, which grows with help of advancement of technology is always positive and beneficial.
  • High potential returns: This is a real wealth creating sector. A small Biotech stock which has a value around $1 – $5, can easily give us a bigger returns (100% – 1000%), if that biotech company manage to get the approval license for drug to sell in commercial market.
  • Biotechnology is a fairly complicated space: So most investors try to stay away from it. This means less competition and we can move faster than, we can with other stocks. It is not easy to find these kind of spaces often, where we can find this edge.
  • Resistance to broader market trends: we have witnessed how market collapsed during housing crisis and Covid pandemic. The stocks related to hotels, airlines as well as finance witnessed their worst year of the decade in Wall Street. The reason for this is, during a crisis people don’t want to spend for luxury. But health is not a luxury, they need to spend on medical health no matter what the social and economic situations are.

 

Drawbacks

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 Clinical Failures: clinical trials are the most important steps of getting a new drug approved for marketing. There are four phases we must, in between order to consider a drug successful. Phase 1 trails focuses on the safety of the drugs on humans. Phase 2 trails deals with testing the efficiency of the drugs and phase 3 is where we validate the earlier clinical studies and decide whether it is eligible for approval.

The final phase (Phase 4) is commercial stage. The drug may have a promising test results, yet it can be prone to lose money, if we fail to commercialise and market it properly.  It can also happen when competitor performs better than this.

Approval Rate: It is very hard to get a drug from lab to market. Only 70% of drugs that enter phase 1 make it on to phase 2. Of those survivors 30% make it through phase3. That means only less than 10% of drugs that complete phase 1 will enter the market. This is likelihood of drug approval.

 

How to tackle these drawback and reduce risks ?

Exchange Traded Funds (ETF):  Exchange traded funds, is a collection of stocks from a similar sector.  Well, apple is in the XLX technology sector. XLX is an ETF.  Inside XLX, there are Facebook, Amazon Apple, etc. Instead of buying one individual company’s stock, we could buy ETF, (a collection of different company’s shares). So if Apple has a bad day and you own ETF which have Apple in it, this doesn’t affect you that much. Even one stock go lower, ETF can still go higher, because it has more than one company’s stock.

So buying a Biotech ETF provides you Instant access to dozens and hundreds of individual biotech stocks. It allows to spread your money across vast variety of stocks. We can sell and buy it like normal stocks.

Contract Research organizations (CRO):  Getting a drug through the approval process and conducting those clinical trials not only takes a long time but also it’s extremely expensive. That means they are going to be spending heavily on clinical trials. The advantage of buying a CRO is that they are the ones that are directly benefiting from that spending. They are also directly benefiting from that long lead time. CRO will partner with biotech companies and they handle all facets of the clinical trial process. In a nutshell, the great thing for investors is that the CROs make money on the drug basically no matter what the outcome is. If a drug fails to live up to expectations, the CROs still gets paid for conducting a trail.

Invest in the Pick and Shovel Providers: What about investing in the companies which manufacture syringes, plunger stoppers, safety devices? The increase in demand of a drug means number of people using that also increased, which naturally leads to more demands for products that help the drug to get into our body. This also include the vials, bottles and packaging. Find top tier suppliers in this sector and invest! This can never go wrong.

 

For example, West Pharmaceutical is one among the pioneers in this sector. They are actually up about 520% returns for shareholders inn past 10 years. That’s kind of the return that just smashes the index. They supply items for pharmaceutical, biotechnology companies and even generic medical companies as well. 

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Long Story Short

Let’s say we are standing at the edge of a funnel and government is in the top of it. They pour billions of money through this funnel straight into Biotech and pharmaceutical sector. The money haven’t come down yet! That means for next couple of months, we are going to see a massive explosion of funds and investments in Biotech sector. We are also going to get introduced into digital health. In next 50 years, diseases with few effective treatment now, can be controlled by medicines that will be produced according to digital information from inside our genetics.  We are now doing things that were unimaginable before 10 years. Our ability to read DNA have increased 1000 times in 10 years. Would you believe if I say, DNA sequencing required 20 million dollars in 2004 and today we can do it with price of an iPhone.

An important key to investing is to remember that stocks are not lottery tickets. Stock market bubbles don’t grow out in thin air. They have solid basis in reality. I believe the biotechnology wave happening now is similar to the information technology wave of the 1980’s and 1990’s.

 

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