Many biotech companies have seen soaring valuations as rapid advances in biotechnology have resulted in innovative new therapies. But how can wary investors find the right companies to back — companies like ProtoKinetix (PKTX), with lean corporate management, a world-class research team, and a robust pipeline of promising research?

Although biotech investing can seem like a firehose of capital appreciation to the outside investor, it’s not always easy to understand how to pick a company that can go the distance. It’s also tough to learn how best to acquire positions in these companies, some of which may trade on the OTC markets and with very little volume. Fear may keep some of these investors from taking the risk — therefore shutting them out from the massive upside potential.

Learn more about the ins and outs of investing in biotech so you can gain the knowledge necessary to make wise investing decisions and secure your financial future.

Common Biotech Investing Questions

• Why is investing in biotech so challenging?
• Who is investing in biotech?
• Pharmaceutical vs. biotech investing: Which is better?
• What should you look for when investing in a biotech company?
• What trial phase is best when investing in biotech?
• How does understanding the FDA affect biotech investing?

Why is investing in biotech so challenging?

The most common, logistical reason investing in biotech is challenging is because so often the companies that are exploring this field are young companies. With this youth often comes low prices and, relatedly, low volume. While one of the major appeals of investing in biotech companies is the massive upside potential, the fact is that young companies that operate in such a burgeoning space often trade for pennies, and over-the-counter stocks have garnered frankly unfair attention from FINRA and the SEC. Investors are skittish as a result, and the low trading volume makes it difficult for interested investors to find good entry points.

The other common-sense reason it can be so difficult to invest in biotech companies is because even value investors don’t have much data to go on. With young companies in a highly technical field like biotechnology, it takes specialized information to make educated decisions as to the likely probability of success. You must be educated in terms of not only the science but also government regulations, investor behavior, and the specific market risk of the sector — research that not every investor is willing to undertake.

However, when the upside is so attractive(with anywhere from 200%, even 5,000% depending on when one enters),  it can be worth the work required and patience to wait for the vertical. When a company does launch vertical it reaches a critical catalyst that most investors will miss without getting in earlier. Investing in biotech stocks presents such of wealth of opportunity for not only the individual investor, in terms of wealth, but also for health and human advancement. The kinds of research and advances being made on a near daily basis make an investment in biotech one that pays off not just financially, but also in terms of human benefit. Selecting companies with broad use of benefiting patients is one good strategy.

Who is investing in biotech?

So, who is investing in biotech? Who is biotech investing right for?

Long time horizon

It won’t surprise you to know that a large portion of biotech investors are in it for the long haul. They’ve diligently spotted opportunities in the industry and acquired a good position with the hope and expectation of that position appreciating down the road.

And for many people, this technique has already paid off.

However, with the state of the industry, as well as the market, it’s a changing dynamic. Many investors have allowed themselves to be deterred by FINRA and the SEC, fearful that OTC trades are in some way harmful, instead of trusting their own research to find the diamonds in the rough.

But others have found reliable methods for dealing with the challenges of biotech investing.

Educated investors

Key among these is investor education: Learning and applying techniques such as limit orders that protect against massive losses while opening up opportunities in the market. It’s important to understand and be able to take advantage of the difference between market orders and limit orders when trading volume is thin.

Getting in on tightly traded stocks with low volume takes practice and foresight. Especially in the biotechnology industry, when so many investors have secured their position and are hanging on with a diamond grip. However, there are traders who are willing to give up their position for the right price, or those who are eager to catch a drop while day-traders are exchanging stocks. Strategic, informed trading will help you locate these opportunities. Rather than setting a price target, one should set a price range to give you security and flexibility to buy in at the right moments.

Relying on technical indicators can help you identify the right entry points for your desired company. Even something as simple as starting your trades early in the day, at market open, will give sellers the opportunity to respond to bids. Consider a price premium to spark interest (e.g. setting your limit order 15-20% over the previous days close just prior to market, may entice someone to let go of their grip on stock giving you the advantage of the long shareholder).

Of course, the platform you trade on can influence your success as well with commissions and fees affecting the spread, and when price volatility is low, that can actually be a huge limiting factor in terms of order volume and price.

Try watching the stock daily to find sellers. Time it right, and you can pick up the difference.

When your limit order won’t let a trade go below a set price per share, you have an opportunity to build a ladder of acquisitions where you close your price range while you increase your volume on order and watch your position grow. Then patience becomes the name of the game.

Investing tips:

• Set your range
• Look at the spreads
• Put in limit orders that protect you on the buy or sell
• Be greedy on volume in buying (all-or-none trade) and greedy on price in selling (limit order)
• Prepare yourself for price swings of up to 50% and take advantage of them long term

Pharmaceutical vs. biotech investing: Which is better?

While both pharmaceutical companies and biotech companies seem to share common goals, their risk profiles (and potential rewards) vary enough that investing in each is a different proposition. Defining which is better depends on your objectives. Generally pharmaceutical companies have products in the market gathering revenue (larger market caps), whereas most biotech companies are pre-revenue (smaller market caps).

Investing in biotech stocks is much more volatile than investing in pharmaceutical companies. The upside is often more significant, but there is much more risk involved. Whereas large international pharmaceutical companies can deliver plodding (though good) returns, biotech companies offer explosive growth and knockout potential for pennies on the dollar.

One solution to this dichotomy is balancing the two among other equities in your portfolio and diversifying your holdings.

What to look for when investing in a biotech company

It should be abundantly clear that investing in biotech is not a guarantee for continued growth and success. Experiments fail, the science doesn’t pan out, the FDA slams on the brakes, or company ownership falters or makes missteps.

As with any investment, it’s up to the individual to do their due diligence and thoroughly research their investment targets. No one can predict the future, but an informed investor can make the best educated guesses.

When seeking a biotech company, look for one with solid financial footing, reputable research results, and a clear path to profitability.

Consider the following factors when deciding whether to invest in a biotech company:

• Company management: How effective is the leadership?
• Financials: Is debt dragging down their R&D?
• Market opportunity: What is the market potential for the product?
• Science and research: What stage are trials, and how is the pipeline?

If any of the above factors is faltering, you risk making a losing investment. All four should be strong for the company to stand the best chance of success.

Consider also the strength of the competition and the lifecycle stage of the company in question. While these two factors allow for much more mutability, proper timing is important in both areas. The closer a company is to their IPO, the less likely to survive long term; so look for companies that have staying potential that have already made it past 5-10 years and show continuous growth. This growth can be not only in share price, but in product diversification or application intellectual property or other signs of advancing manufacturing development.

What trial phase is best for biotech investing?

In terms of timing, pay special attention to the trial phases as they intersect with your investment goals. Your entry and, if applicable, exit points may be determined by clinical trial phases.

For example, if you plan to exit in two years or less, phase 2 trials can make a good entry point especially for small-cap biotech companies. Trials in this phase may be double-blind, with placebo controls, offering more accurate and more conclusive (and sometimes quite exciting) results. Positions acquired during this phase can be very profitable. Positions taken just before this phase, such as pre-clinical or phase 1 success can offer a greater multiple but have higher risk. Promising scientific returns generate interest, and interest drives up the price. Timing your exit to take advantage of these gains can result in maximized profit

On the other hand, if you aim to invest for long-term returns, you may be better served by investing during phase 3 trials. In this case, the time to get in is when you’re in clinical trials -- the early stages have already shown promising results, but now is when the rubber truly meets the road. Strong phase 3 trials (which test a greater sample size) indicate truly inspiring potential. While clinical-stage success is no guarantee, the field of successful biotech therapies narrows greatly during phase 3 trials, so success in this stage combined with smart leadership provides a sharp ramp upward to profitability.

The problem with buying companies after success in phase 2 or 3 for an individual investor is that you are competing with retail and institutional investors. Further, pharmaceutical companies may execute a buy-out in the time in between under NDA without you being aware (e.g., setting your limit order 15-20% over the previous days close just prior to market, may entice someone to let go of their grip on stock). Biotech companies tend to “graduate” from the OTC where prices are low to NASDAQ as they advance through pre-clinical, Phase-1 and Phase-2. This invariably means that entry points are more expensive, and upside is reduced for the individual investor.

How does understanding the FDA affect biotech investing?

No investor should invest in biotech without at least a basic understanding of the Food and Drug Administration (FDA), how it works, and how its decisions affect companies in this industry.

The FDA’s drug approval process is a multi-layered decision, with each step (Step 1, Step 2, and so on) an important milestone on the path to full approval so the product can be brought to market.

Step 1 is the development phase, Step 2 is Research, Step 3 is Clinical Trials, and Step 4 is FDA Approval. There is also a Step 5, post-market monitoring, which keeps tabs on previously approved products.

In some specific cases, this process can be expedited through accelerated and fast-track approvals.

It’s important to understand where your target company is in the FDA approval process, not least because it’s an indicator as to where it is on the path to market. Since companies can have more than one product or application on the go at any given time, it takes more involved investigating to understand the status of the different research and the likely forward effect on the company’s bottom line.

Key Takeaways

• Biotech investing has enormous upside, but nothing is a guaranteed home run
• Both short-term and long-term investors can benefit from biotech investing, although strategies will vary between the two
• There are several techniques to use to acquire positions in thinly traded, young companies such as those in the biotech industry, including timing and strategic use of limit orders
• It’s important to understand the phases of the FDA approval process so you can time your entry (and exit, if applicable) to your return objectives in a particular biotech company

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