Biotechnology stocks are one of the most polarizing areas of the investment world. On its best days, this growthy area of health care is able to generate doublers or even triplers overnight on a single news item. But, when things get ugly, things get really ugly, with companies hemorrhaging half their values just as quickly.
Biotech stocks are often gambles, offering investors the chance to win big or lose it all.
So before discussing the issue of whether you should buy biotech funds, perhaps we should ask — should you even buy biotech in the first place?
Biotech stocks have plenty to love, plenty to fear. Biotech made mainstream headlines the wrong way in 2015 when it got caught in the crosshairs of Democratic presidential hopeful Hillary Clinton. Clinton spoke out on Twitter (ticker: TWTR) against a price hike from $13.50 to $750 for an HIV-treating drug called Daraprim — produced by a company that had been swallowed up by Turning Pharmaceuticals, which at the time was run by Martin Shkreli.
The subsequent months went foul for both Shkreli and the broader biotech industry. Shkreli’s reputation has rapidly snowballed as the country learns more about the heinous nature of this “pharma bro.” And pharmaceutical stocks? Well, several major indices for the sector have declined by roughly 25 percent since Clinton’s September tweet, with the losses becoming even more precipitous as the industry has tumbled along with the broader markets in the early months of 2016.
Investor and public sentiment alike have soured on the space, and people focused on biotech don’t even disagree with the reasoning — but also are quick to point out what others might be missing.
Brad Loncar, CEO of Loncar Investments in Kansas City, Missouri, says that “most of those negative headlines are about companies raising prices of old drugs, and that rage is mostly merited. What most people talk about are a small group of companies that have taken advantage of the system. People in the industry are also outraged.”
The upside? “We’re starting to make a distinction between companies that are raising the prices of old drugs and companies that are developing new, innovative drugs,” Loncar says. And that’s good because in many cases, the proverbial babies have been thrown out with the bathwater.
In fact, Loncar believes the daily run of negative headlines plaguing the biotech sector has already been baked into the space.
For every Shkreli, there are hundreds of legitimate stories of companies that need to charge high prices for drugs to pay for the high cost of the journey to get those drugs approved.
“Unlike more general technology companies, which can achieve massive scale and substantial profitability without spending huge amounts of money, the product development cycle and regulatory requirements for biotech/pharma companies typically require tens of millions, and sometimes hundreds of millions, of investor dollars,” says T. Hale Boggs, a partner in law firm Manatt, Phelps & Phillips’ corporate/finance, capital markets and venture capital practice areas in California.
And as far as investing in the space goes? Well, it’s boom or bust — you just have to go into it knowing that.
“Biotech can result in spectacular flameouts,” Boggs says. “Failure rates in drug development remain extremely high relative to other technology businesses. … On the positive side, success in biotech can also be spectacular. The profits associated with successful drug development can be astronomical.”
Paul Yook, portfolio manager of BioShares BioTechnology exchange-traded funds (BBP, BBC) is equally unambiguous:
“If you look at profit and revenue growth over the past 10 years, the majority of it has come from biotech,” he says. “If you’re not invested in biotech, you’re missing out on the secular growth story of our economy.”
Biotech funds are better for most. While being right on the stock picking side of biotech can be lucrative, Jonathan P. Gertler, managing partner and CEO of Back Bay Life Science Advisors in Boston, paints a sobering picture of the difficulty in actually picking individual biotech winners.
“If you’re an astute observer of biotechnology and can identify some of the drivers of value and specific tech platforms — attributes of technology, wisdom of the regulatory plan or clinical plan, unmet need in the space they’re attacking and how disrupting or clinically positive the outcome might be — if you’re a good stock picker, I’d try to identify those companies,” he says. “This is a very sophisticated market.”
Loncar says there’s a great Warren Buffett quote about the general market that he likes to apply to biotech.
“The stock market is like a really fine restaurant that has a casino in the backroom,” he says. “Biotech is like a really fine restaurant that has a casino in the backroom — and you’re not supposed to go back there. The real quality is the main course.”
He says most people simply can’t dedicate the time and don’t have the expertise to make those calls. The result of stock picking in the space, then, is pain for many investors.
“It’s so stupid to bet on individual names,” Loncar says. “People become obsessed with an individual biotech stock — that’s a losing game. You’re always going to end up losing over the long-term. People have done that and tried to make 200 and 300 percent on a single stock, and they lose all their money, and if you had simply owned the sector, you would’ve made large gains.”
A couple of the most popular options in the space are the iShares Nasdaq Biotechnology ETF (IBB) and the SPDR S&P Biotech ETF (XBI). Just don’t wait too long. “Early 2016 presents opportunities to buy,” Yook says. “We will not see numbers this low for much longer, and biotech is cheaper now than it will be at any point in 2016.”
More from U.S. News
10 Ways to Play the Explosive World of Small-Cap Stocks
8 ETFs for Investors Who Love Value
7 Facts Investors Should Know About Insider Trading
Pros and Cons of Buying Biotech Stocks originally appeared on usnews.com