The Single Greatest Mistake You Can Make When Investing in Biotech | The Motley Fool (2024)

Source: Food and Drug Administration via Facebook

Investing in the biotech sector since the Great Recession must be somewhat reminiscent of the pre-dot-com bubble for traders. These days it seems as if you threw a dart at the newspaper you could nab a winner based on where the dart landed.

Based on screening data from Finviz, of the 162 publicly traded biotech stocks that went into the Independence Day weekend with a valuation of at least $300 million, just 38 were down over the trailing year. On the other hand, names like Advaxis, Esperion Therapeuticsand bluebird bioare up 490%, 423%, and 320%, respectively. Even newly public biotech stocks are getting in on the act, with Aduro Biotech more than doubling during its debut in April.

The greatest mistake you can make when investing in biotech
This might give the perception that biotech stocks are easy to understand or are a "sure win" for investors. The reality, though, is that some investors could be setting themselves up for disaster by falling for the single greatest mistake when investing in biotech. This huge mistake is what I like to call "chasing the news."

Chasing the news is the simple act of allowing your emotions and the latest news hype to drive your investing activity.

Source: Flickr user snowlepard

For example, over the last month the media has been honing in on South Korea, which has been dealing with the largest outbreak of Middle East Respiratory Syndrome, or MERS, outside of Saudi Arabia. Through this past weekend, some 185 cases were confirmed, resulting in 33 deaths. MERS, which originates in camels, is deadly to humans about 40% of the time, and there currently is no cure. Therefore, all eyes are on drug developers that could be at the forefront of MERS vaccine innovation.

One such company is Novavax (NVAX 0.72%), a clinical-stage company focused on respiratory syncytial virus vaccines, influenza vaccines, and global diseases such as Ebola. Novavax has also done work with MERS, publishing a study in April 2014 in collaboration with the University of Maryland School of Medicine that showed its preclinical MERS vaccine candidate blocked infection in laboratory studies.

Keep in mind here, we're talking about a preclinical study, so commercialization of the product would be, in my mind, multiple years out. However, Novavax stock exploded higher in June to the tune of 24%. Novavax does have a number of catalysts upcoming in the third-quarter, including data from four of its clinical studies, but the apparent catalyst in June appears to be the MERS outbreak in South Korea.

I would contend that bidding up Novavax shares on the heels of the MERS news is a mistake on the part of investors for three primary reasons. One, as we noted above, is that a commercial product is likely years away.

Secondly, the vaccine market itself can be very hit and miss. Although I'd love to see a MERS cure come to market, because every life is important and worth saving, there's also a matter of economics and feasibility that comes into play. In other words, will it be economical for vaccine developers to spend the money to create a vaccine if only a few hundred cases are reported? Vaccine developers are at the mercy of orders from global governments, and if those orders don't come in, or demand isn't anywhere near supply, then they could eat huge losses.

Lastly, viruses are often mutable, meaning that a working vaccine one moment could be worthless the next based on how a virus evolves. Like the Avian bird flu, we could see variations of the strain come and go without warning.

MERS isn't the only news-chasing event
But trading in potential MERS vaccine developers isn't setting any precedents; it's just the latest in a series of "chasing the news"-type events.

Source: U.K. Department for International Development via Flickr.

Last year investors couldn't get enough of Ebola drug developers. Shares of Tekmira Pharmaceuticals (ABUS 2.43%) were among those that soared. Though its stock is still up an impressive 137% over the trailing two-year period, the initial Ebola concerns sent shares up 500% in less than a year at one point.

According to the World Health Organization, through July 1, 2015 there were 27,591 confirmed, probable or suspected cases of Ebola worldwide, leading to 11,238 deaths. One of those deaths occurred in the United States, and it whipped the media into a frenzy. Like MERS, Ebola has a mortality rate of roughly 40%.

However, Ebola cases have been on the decline in recent months, and the fears of an Ebola epidemic have waned. Tekmira shares, too, have taken it on the chin. At first Tekmira's stock drifted lower simply from a lack of Ebola-based news. More recently, though, Tekmira shares have been rocked by the announcement that it was discontinuing its enrollment for TKM-Ebola-Guinea, a midstage Ebola vaccine that wasn't demonstrating the desired therapeutic benefit that Tekmira had hoped for. Even if Tekmira's drug had hit the mark, it would have been facing more than a half-dozen other competitors working on an Ebola vaccine.

Source: Tekmira Pharmaceuticals

How to avoid chasing the news
Smart biotech traders can avoid the dangers tied with chasing the news by employing some, or all, of the following tactics.

The first is really simple: think longer term. I understand that the promise of investing in cures for Ebola or MERS might seem like a winner for a few weeks or even months, but what happens when the prevalence of these somewhat rare diseases begins to die down? Your best course of action is to approach each trade with the mindset of holding for at least a couple of years. This way your investing thesis has time to play out, you can potentially take advantage of the effects of time and compounding, and when you sell you'll pay much less in capital gains taxes.

Secondly, think long and hard about the therapeutic indications that the biotech stock you're buying is targeting. Infectious disease companies targeting MERS and Ebola may be hit or miss, but chronic global conditions such as HIV/AIDS, influenza, hepatitis B, hepatitis C, cancer, and so on, offer an opportunity to cure millions upon millions of already infected people. Chronic disease drug developers may face plenty of competition, but most indications offer plenty of room for multiple therapies. As an example, with 180 million people infected worldwide, hepatitis C is an indication that could probably support a half-dozen approved products, or perhaps even more.

Finally, consider waiting for a biotech stock to prove its worth to investors. I can't recall how many times now I've witnessed a stock run-up 50%, 100%, or more following positive phase 1 or phase 2 data only to be decimated in phase 3 clinical trials or by the Food and Drug Administration. Waiting for the release of late-stage data or even an FDA drug approval may mean you miss an initial pop in a biotech stock, but it'll likely bring you better peace of mind and reduce your chances of losing money over the long run.