There's no need to be afraid of biotech

In my post yesterday, where I discussed the signs of a possible comeback in biotech, most in the comments expressed a strong aversion to the asset class and its unpredictability. Now I’m not saying to be greedy when others are fearful, but… it is worth noting that this broad investor reluctance could suggest an overlooked opportunity.

No doubt biotech is risky, but it also has the potential for big returns. I believe it can be a valuable addition to a diversified, long-term portfolio, and I'm here to help navigate the learning curve for those interested.

Here are questions I ask when analyzing a biotech company:

(R&D Track Record/ Pipeline)

• Does it have multiple drugs - opposed to a single drug - in at least Phase 2 testing? Single-candidate biotechs can crash hard if their one and only product candidate fails.
• How far along in the development pipeline are its therapies? The further along they are, the better their chances of regulatory approval and commercial success.
• How many products has the company successfully brought to market? A history of product approvals demonstrates experience in navigating regulatory processes.

(Market Opportunity)

• Not all diseases are equally valuable. Is the company targeting diseases with large patient populations, or conditions for which there are unmet needs?
• What are the peak sales figures for its therapies?
• How big of a risk is there of competition from larger players?

(Key Partnerships)

• What are the terms of its partnerships? Do these terms give insight into how the market values its products? A good licensing partnership agreement includes not only generous royalty rates on future sales, but healthy upfront payments - plus milestone payments for achieving development targets.
• Do partners show lasting commitment and have ownership stakes in the business? Understand partners’ motives and incentives.

(Financial Stability)

• Is it well-funded? The product-development process can be long and expensive. Having a strong balance sheet means a company can continue to invest in R&D without having to accept partnerships on unfavorable terms.
• What is the company’s burn rate on cash, and how long will their cash last? Cash is more important than ever in the current high rate environment.

(Management)

• Does management have relevant industry experience?
• Does management have a record of putting company's resources into projects that offer high returns on investment?
• Does management have a track record of meeting publicly-stated goals and development milestones?

When it comes to understanding the science behind a companys' therapies, and for deciphering efficacy data and clinical trial data, Fierce Biotech and STAT News are excellent resources. STAT has a paywall, but one of their top commentators, Adam Feuerstein, is a sage and is worth following on Twitter.

If studying individual companies is beyond your comfort zone and you prefer more of a basket approach, the biggest biotech ETFs include the iShares Biotechnology ETF (IBB), SPDR S&P Biotech ETF (XBI), and the Ark Genomic Revolution ETF (ARKG). These ETFs have had annualized returns of 6%, 10%, and 7% since inception, respectively. Each has different risk profiles, with Ark having the highest beta.

I would like to stress that not everyone should invest in biotech, and I especially don’t think anyone should be overweight in biotech or high-growth. However, if you're a long-term investor with a diversified portfolio of at least 15-25 stocks and are wanting more growth exposure – biotech is a great option to consider.

The ETFs I mentioned have experienced downturns in the past, but have consistently recovered to new heights. And right now, price-to-sales multiples of the XBI compared to the S&P 500 are at their lowest levels since 2013. The near-term is murky, but for the most part, I believe we’ll look back on this period as a darn-good time to invest in biotech.