Biology Investments: 2 Niche Stock Picks

Note: In addition to my regular discussion on select companies in the life science (“applied biology”) space, I’ve included a top-down discussion and exemplification of my main categorization method. For those not interested, company-specific discussion can be found near the end of the article.

What kind of company is this?
Life science (biology) investments can be very hard to categorize. While virtually every stock I look at is correctly labeled as a healthcare or biopharmaceutical equity, this label tells me next to nothing about the expected behavior or the risk/reward of the stock. From an investment standpoint, there is a huge difference in expectation between a large pharmaceutical stock and a small one. There are also huge differences between generic and regular pharmaceutical companies, although this may not be reflected with categorization.

Some ETFs are available for investors who want to take wider “shotgun” approach to bio investing, although this method can be very problematic due to the way these funds are weighted (sometimes just by market cap). Prepackaged categorical investment products offer very little customizability, and blind investors to the actual risk/reward of the fund as a whole.

This all stems from one main problem - life science stocks are very heterogeneous investments. While petroleum equities may have a direct correlation to the price of oil, pharma stocks will generally trade in a separate little universe.

While it’s still important to look at each company individually, I think that investors can perform the most important sort between life science companies with one simple question:

Does this company need to conduct clinical trials to generate consistent income?

Clinical Life Science Companies (Yes)
These would be companies that are developing or commercializing life science-based products for use in the clinical setting. Drug developers, diagnostics developers, and class III medical device companies would fit into this category. From an investment perspective, the small companies in this category are generally high risk/reward investments, and returns often take a long time to materialize because of the FDA approval process. Medium or large companies are generally considered more “stable”, and they usually produce strong cash flows – therefore reducing risk of bankruptcy while reducing reward.

Examples: Celgene (CELG) ; Neurocrine Biosciences (NBIX) ; ChemoCentryx (CCXI) ; Navidea Biopharmaceuticals (NYSE: NAVB)

Almost all of the life science companies that I cover are healthcare product developers in the clinical development stage, so they would fit into this “clinical life science” category. Whether it’s a newly made drug or medical device designed to administer drugs more efficiently, these may need a 7-10 year window to fully complete the “clinical development” stage. Although these drugs/devices may demonstrate efficacy in the laboratory, human testing is necessary to officially demonstrate the clinical utility and safety of any product. This is why clinical trials are required for FDA approval.

Get The News You Want

Read market moving news with a personalized feed of stocks you care about.

Get The App

Generally speaking, clinical development requires millions of dollars each year for both R&D expenses and SG&A expenses during this lengthy period. This is why it’s especially disappointing to stakeholders new drugs or devices fail to receive FDA approval after years of hard work and patience. These products are also quite vulnerable to bad clinical trial data releases, because these generally cause investors to lose faith in a company or product. This results in substantial devaluation and selling of the associated stock.

Valuation is way more tricky for clinical life science companies, and can only be calculated with big assumptions about a company’s chances for FDA approval and proper commercialization. This is often done with careful analysis of available clinical/preclinical trial data, and comparison to other products in the industry.

Overall it’s a scary and volatile little corner of the stock market, which is why many investors avoid developmental drug and device companies altogether. However; the risk profile changes quite a bit if the company reaches the commercialization stage. If the product launch is handled well, the company can generate substantial revenues at great profit margins, which supports the stock valuation with cash flow. While there is less potential for explosive gains, these commercial-stage companies (which are sometimes developmental/commercial hybrids) can still grow and outperform the broader market.

Industrial Life Science Companies (No)
These would be companies that are developing and commercializing life science-based products for use in various industries that don’t require clinical trials and FDA approval. Most generic drug manufacturers, Class I/II medical device companies, high-tech agricultural companies, certain chemical companies, and others might be put in this loose category. The key difference with these companies is that they do not need to conduct clinical trials, which completely changes the nature of these types of stocks. For small or medium companies, the risk/reward should generally be lower compared to similar-sized companies in the clinical life science category.

Examples: Purdue Pharma (Private) ; MusclePharm (MSLP.OB) ; Biozone Pharma (BZNE.OB) Bioamber Inc (NYSE: BIOA)

Although many generic drug manufacturers can be considered quasi-clinical, these companies produce revenues and can be better evaluated by financial performance. The is also true of medical device companies that are commercializing Class I and most Class II devices, which are considered relatively “generic” and low-risk for use by clinics. Companies that develop Class III devices behave more like drug developers, and usually require clinical trials.

Unlike clinical life science companies, investors can effectively value these companies based on just financial data, near-term projections, market size, and analysis of any potential competitive edges.

To better define this industrial category, I’ve included discussion on two recently-discovered companies that fit quite well.

BioZone Pharma
Investors who follow the revered healthcare investor Philip Frost should be familiar with BioZone due to the recent licensing agreement between his flagship company, OPKO Health (OPK) and Biozone (link )

Closing Comments
Although the system isn’t perfect, I think that investors should definitely know whether or not the life science company they’re considering as an investment needs to undergo a lengthy clinical development stage prior to commercialization. From my observations, I’ve found that many individual investors don’t actually know what they’re getting themselves into when buying an early-stage drug developer. Some would be better off with what I call “industrial” life science companies which are generally more stable, safer, and much easier to understand.

This is not to say that investors should necessarily avoid small or medium-sized clinical life science companies. The high risk comes with a high potential for return, although investors will probably have to spend a lot more time with their due diligence. Also required is a strong stomach for the volatility of these sotkcs.

Written By: Myriad Equity