Understand, though, that this sector is fraught with risks. As I’ll show you, there are certainly opportunities to make good double-digit returns here, especially among smaller biotech companies. But you need to choose very carefully.
In a recent report, European Biopharmaceutical Enterprises (EBE) said some biopharma companies were struggling to attract investment even before the credit crunch. Not surprisingly, venture capital investment has slumped since credit dried up. The EBE predicts one in five of the sector’s companies could go bust if new funding doesn’t emerge soon.
That means that if you want to go after the enormous potential in this sector, it’s worth doing some legwork to find the right sort of company. That’s where I’d like to help you…
There are four basic requirements for successful investment in the biotech sector. If a company can meet most of these, it’s worth a good look.
Why financial strength is a must-have for drug stocks
The first is a company’s financial strength. To illustrate this, let us look at the situation that a company with barely adequate funds finds itself in.
There are many biotechnology companies in this situation. They typically raised money before the credit crunch to develop new drugs. Now they have spent much of their cash pile. And yet they have minimal sales and their lead drug is nowhere near completing clinical trials.
That means that safety and efficacy are not yet proven, so the drug is far from market launch. This is a ‘catch 22’ situation. The company should be able to raise funds once the lead drug passes through at least the first few clinical trials. But they need more money to get to this stage. And what if the lead drug fails in later clinical trials?
There are two likely options for such a company. The first is to try to engineer a take over by a larger company with deep pockets. The second is to do a licensing deal with another company for the lead product. The problem is that the company has a poor negotiating position in either case and shareholders will suffer.
The clear message is that you need financial strength. And in these markets, that means you need a lot of cash. It needs to be sufficient to support several years of cash drain or cash ‘burn’ as it is called in the sector. This cash needs to be sufficient to take the company well beyond the point that its first products are earning money in the market.
The second thing I like to look for when choosing a company in the biotech sector is whether it has strong links with wealthy customers. This usually means large pharmaceutical companies.
The successful smaller company will have signed collaboration agreements with one or more larger pharmaceutical companies that give it ‘milestone’ payments. These are down payments that are made to the smaller company when its research and development (R&D) programme meets the agreed specification at the end of each stage of drug development. There should also be licence fees, royalties and/or profit sharing arrangements when new products are launched on the market.
If a company meets these first two conditions, I get interested. But we need more...
The third and fourth requirements for success are connected to the first two. The smaller company needs a clear focus on one particular disease area or technology and an interesting pipeline of potential new products in that area.
Making sure the pipeline can attract the big fish
Large companies need to see the potential for a worthwhile and longer-term collaboration which will provide several possible new products for them in one of their mainstream areas.
The pipeline should ideally contain products at different stages of development and with different risk profiles. This means that each year or two will see new income producing products emerging from the pipeline. The icing on the cake would be success for the occasional, higher-risk product that could make a lot of money.
Of course, there are no guarantees. So if you like the defensive qualities of the drugs sector but want to be able to sleep at night, consider “Big Pharma” stocks like AstraZeneca (ticker: AZN) and GlaxoSmithKline (ticker: GSK) for the long term.
The stock I’m recommending is a little racier. But it stands up well to the four “must have” criteria I mentioned above...
It has a substantial cash pile that is more than seven times its annual cash ‘burn’. It already has agreements with several large pharmaceutical companies. It has maintained a clear focus on one particular technology. And it has a pipeline of many products under development that make use of this technology.
If you’re open to a higher-risk/higher-reward play in the biotech sector and would like to read more about this company, check out Research Investments today.
Good investing,
Dr Mike Tubbs
For The Right Side
Editor’s recommendation: Mike Tubbs has just released an in-depth report on this exciting biotech stock to readers of his Research Investments newsletter. He predicts this share could deliver returns of between 50% and 100% for investors who buy in now. Click here to receive this report by return.
MARKET NOTES
Big Pharma going great guns…
BY SHIVVY ARORA
While stock markets have taken a beating for over a year now, one sector has enjoyed much better fortunes.
Take a look at the chart below. It shows the pharmaceuticals sector index compared to the FTSE 100 for the past year. You can see that the FTSE 100 (in blue) tumbled by more than 30% from mid-March 2008 to date. However, the pharma index (in pink) gained by over 6%.
Pharma & Biotech continually outdo the market...
Source: Digital Look Like other defensive sectors, the pharma & biotech sector has been strong as consumers don’t stop purchasing drugs just because times are tough. The sector is also known to be less dependent on capital (assets such as tools and machinery) than other industries such as autos, steel or petroleum. It is more of an income generator, with successful companies sitting on very strong net cash positions.
Big players such as GlaxoSmithKline, AstraZeneca and Pfizer are continuing to invest heavily in R&D activities in the UK. Research is crucial to boost the quality of output and develop new drugs. Strong, effective R&D investment should also mean the sector stays ahead of the game – and the markets.
If the markets continue to show the weakness that we have seen over the past 12 months, expect the drugs sector to continue outperforming as investors seek defensive shares.
The Daily Reckoning – Bulls, bears, spenders and savers will all be whacked
BY BILL BONNER
Los Angeles, California
Tuesday, 7 April 2009
Keep moving up those stop losses!
The Dow took a breather yesterday. The index was down 41 points.
But as far as we can tell, the rally is still underway. The G20 meeting is widely seen as a triumph. The money is flowing. People think we’ve seen the bottom.
“Cramer: The Depression is over,” says a headline. Jim Cramer says the bottom has come and gone. That’s all we need to know. If Cramer thinks the worst is over... well, it must be so.
Even Nouriel Roubini, according to Forbes, thinks there is “light at the end of the tunnel.”
Japan says it’s going to announce another $100 billion stimulus program this week. That should do the trick. After 17 years of bailouts and stimulus programs, the Japanese should be getting good at them. But it’s a little like a guy who’s getting good at suicide – if he’s so good at it, you’d think he’d be dead by now.
But no, the Japanese economy is still one of the worst performers in the world; their bailouts and stimuli have done no good... maybe they’ve even made the situation worse.
No matter, there’s a rally on – this is not the time to ask questions. Our instinct tells us this rally is going to carry the Dow back above 9,000... possibly above 10,000. Why? Because people do not go directly from believing nothing can go wrong, to believing that nothing can go right. The kind of delusional optimism that took stocks up to 14,000 on the Dow... and doubled property prices... and had sober bankers buying billions’ worth of ticking debt bombs doesn’t disappear overnight. It has to be killed like Rasputin – many times. Stab it. Shoot it. And then douse it with gasoline and set it on fire. Maybe then, it will finally die.
That’s why this rally is just a trap for the unwary, a suckers’ rally... Investors are getting back on their feet just so Mr. Market can whack them again. So, if you’re playing this rally... be sure to keep those stops moving up behind your stocks.
So far, this rally has recovered less than 20% of the previous losses. Typically, at least one good rally in a bear market will recover more than half of the losses.
Looking at the long term, the Dow rose from the low in the early ‘30s of only 41 points to the high in 2007, when it was over 14,000 points. This bear market wiped out more than half of the capital gains made by investors during that whole 76-year period. A 50% bounce from the January low would put the Dow back up close to 10,000.
But we gave you our forecast yesterday. Bulls, bears, spenders, savers – our guess is that Mr. Market intends to paddle them all…
Read on…
To read the Daily Reckoning in full, click here.
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