Investing in the Biotech Sector: 5 Elements To Consider

When Arena Pharmaceuticals (Nasdaq: ARNA) released positive Phase III data on its obesity drug, Lorcaserin, many people expected shares to take off. 

After all, the company’s press release on Monday confirmed that the drug had proven to be safe and effective. 

But in a classic example of just how volatile and unpredictable the biotech sector can be, the stock slumped 28% instead. While the news was good on the surface, the problem was that Lorcaserin didn’t help patients lose 5% more of their body weight than placebo. The 5% figure is a guideline that the FDA uses for approvability – and investors punished the stock for not meeting that requirement. 

Let’s dig into the story and apply the lessons from it to investing in the biotech sector… 

Investing in the Biotech Sector Is Not Easy 

Investing in the biotech sector is not easy. 

In fact, I’d argue that it requires more due diligence than just about any other sector, simply because of its unpredictable nature and that the science sometimes can’t match people’s hopes for a drug. And when there’s a lot of buzz around an important drug that tackles obesity – one of America’s leading healthcare problems – it can exacerbate the fallout. 

Even the very best investors in the biotech space have had stocks blow up on them after bad clinical trial data. It’s part of the business. As I’ve said here before, when you try to capture the potential enormous gains that biotech has to offer, you take on some extra risk. 

With Arena Pharmaceuticals, that risk outweighed the reward – and I outlined my reasons why at the Investment U Conference in St. Petersburg, Florida just this past weekend. 

How to Find Winners In The Biotech Boom 

As I explained in my workshop, “How To Find Winners In The Biotech Boom,” there were a few things about Arena’s story that I found risky… 

• Competition: Whenever possible, I like biotech companies with drugs/devices that face little or no competition. But several other companies, including Vivus (Nasdaq: VVUS) and Orexigen Therapeutics (Nasdaq: OREX), have obesity drugs that are in late-stage development. So even if Lorcaserin was effective and Arena had “first mover” advantage, it would likely face competition in the near future. 
• Results: In Phase II trials, Vivus’ and Orexigen’s data was stronger than Arena’s. Moreover, Vivus has already shown effectiveness in one Phase III trial. Results from two more are expected this summer. 
• The Fen-Phen Issue: In 1997, popular weight-loss drug fen-phen was withdrawn amid reports that its caused heart valve disease. So when Lorcaserin was described as the chemical cousin to the drug, the relationship didn’t sit well with me. 

In short, the possible safety issue and the potential for better drugs to enter the market soon meant the reward wasn’t high enough to justify taking on the substantial risk. 

And when we’re talking about biotech, avoiding unnecessary risk is critical. You can be sure that if I decide to take on additional risk, you can be sure that the potential reward will be very significant. 

Investing in the Biotech Sector: A 5-Step Stock-Picking Method 

Before investing in the biotech sector, I use a five-step stock-picking method. Here’s how I pick healthcare and biotech stocks… 

When I select companies for my healthcare service, Access, I rely on my F.I.R.S.T. research methodology, which focuses on Financials, Interviews, Research, Safety, and Timing. 

I spend a tremendous amount of time separating the companies and stories that merely make interesting reading from those that go one step further and make solid investments. 

Many of the companies I recommend are well under-the-radar. Don’t expect to hear them being pumped on CNBC, Internet message boards, or in the mainstream financial press (yet). 

Most of them are in what I call the “gathering period” – when influential investors, insiders, and sector specialists are accumulating substantial positions ahead of breakthrough news and/or product announcements. 

While these catalysts often lead to short-term share price gains, more importantly, they set the stage for substantial moves higher over the intermediate and longer-term. 

Don’t get me wrong… Arena was an appealing story. But there are lots of exciting stories in the biotech sector. And the company failed on a couple of major issues. 

When investing in biotech, understand that blowups happen. But also know that it’s a sector capable of producing gains of 10,000% or more. Just ask the investors who bought Amgen (Nasdaq: AMGN), Celgene (Nasdaq: CELG) and Biogen Idec (Nasdaq: BIIB). 

Even in this crummy market, Access subscribers are sitting on current gains of 97% (on a position initiated in October) and 23% (in just one month). You just have to know where to look. 

Hoping your longs go up and your shorts go down.

Marc Lichtenfeld
Smart Profits Report