Biotechnology is one the strangest, scariest, sexiest and most interesting corners of the stock market. In how many other industries are companies striving to literally save lives? Any industry can host a stock that could potentially double, but what other industry can match biotechnology in the sheer number of stocks that could double if their companies' plans all come to fruition?
TUTORIAL: The Industry Handbook - Biotechnology
On the other hand, in how many other industries do companies burn through hundreds of millions of dollars, often with nothing to show for it? How many other industries rely on scientific arcana that can be challenging to even highly qualified Ph.D.s? And how many other industries sport a warning label that reads "Caution: Poor stock selection may cost you 90% of your initial investment"?
For all those reasons and more, biotechnology is a fascinating industry for investors to explore. (For a background reading, see .)
What Is Biotechnology?
In a nutshell, biotechnology is an industry that focuses on novel drug development and clinical research aimed at treating diseases and medical conditions. Biotechnology companies are almost always unprofitable (some suggest that the distinction between "biotech" and "pharmaceutical company" lies in profitability), and many have no real revenue at all.
Biotechnology is also characterized by long development lead times; it can take as much as a decade to get a new drug from test tube to pharmacy shelf. What's more, there is an overwhelming likelihood of failure, as 85-95% of all prospective new drugs fail to reach approval. Still, for those that succeed, the rewards can be tremendous and "daily doubles" are not unheard of.
The Differences Between Biotech and Pharmaceuticals
There is more than a little gray area between what is "biotech" and what is "pharmaceutical". Nevertheless, investors should keep a few general points in mind. From a philosophical standpoint, biotechnology is a risk-taking enterprise, while the pharmaceutical industry is about managing and diversifying risk.
Many biotech companies make no pretense of marketing their own drugs, as they see their expertise being in R&D. By comparison, marketing and sales is the principal strength of many Big Pharma companies. As more and more pharmaceutical companies fire scientists and pull back from basic research, they increasingly become massive marketing machines that need an influx of new products from the biotech world.
The two industries also stand apart when it comes to valuation and business evaluation. Models and valuation derived from cash flow are quite relevant in assessing pharmaceutical stocks; while many analysts gamely attempt to construct discounted cash flow models for early-stage biotechs, the reality is that success is often quite binary ("drug works" or "drug doesn't work"). (For more, see .)
Beware the Gatekeeper
As the regulatory body that approves new drugs for the U.S. market, as well as permitting human clinical trials, the Food and Drug Administration (FDA) is the ultimate gatekeeper to every biotech's success. The FDA requires that all companies establish (to its satisfaction) that a potential new drug is safe and efficacious for its stated purpose. (Learn more about the FDA's impact on pharmaceuticals, check out )