3 IMPORTANT TIPS FOR BEGINNING BIOTECH INVESTORS

Covid-19 has hit America hard, and now we are hitting back! As biotech firms race to create effective vaccines and cures for Covid-19, the world of biotech has landed in the spotlight. With skyrocketing valuations and a torrent of positive Media coverage, there is no doubt that Biotech is attractive to the beginning investor. The sector offers strong returns for years to come.

But how to capitalize on the hot trend without getting burned? Financial Guru Brandon Smith offers some solid tips to our readers…

Biotechnology companies and stocks have been around for decades now. They are a main driver in the innovation of the healthcare industry. We’ve seen companies like Amgen ($AMGN), AbbVie ($ABBV), and Gilead ($GILD) develop into industry leaders. The importance of having an in-depth understanding of this industry is due to the story stocks that come and go all the time. We need to locate solid financials to assess if the company can sustain as a biotech firm. Here are three tips to understanding these stocks better.

1. Focus on strong companies that make money, and are positioned to make more of it in the future.

The first place to look is at the market capitalization of the stock. Understand that market cap’s that are under $300 million have the ability for the stock price to be manipulated. Value plays in the biotechnology space would have market capitalizations north of $100 billion. If you chose to chase a smaller cap company then please be mindful of ability for firms to almost dictate the price movement. The larger the market cap of the stock, the better chance of sustainability as well as stability. These are companies like Pfizer ($PFE) which has over $205 billion in market cap.

The next step would be to seek companies that have a low, but positive Price to Earnings ratios. The price to earnings ratio is the current price of the security divided by its annual earnings from the last full year. Compare the stock you are interested in with the industry average to judge if it is cheap or expensive for the current market. From there, you can then build a five year range for the p/e. If it’s towards the low end of the spectrum, then it is undervalued; in correspondence, the high end of the spectrum would then indicate that the securities are relatively overvalued. It’s a necessity for companies to make money; without cashflow, the chance of survival dwindles.

Following up the P/E ratio you would want to then look into the quarter over quarter EPS (Earnings Per Share) growth. Strong Quarter over Quarter growth signifies the company’s capability of growth. Small firms should be growing almost exponentially considering they have the most potential if a drug or treatment is a big success. The bigger biotech firms who have already captured a large percent of the market share for their product may have lower numbers, but they should still be positive quarter over quarter and even year over year. The caveat to this is to factor in the black swan event that the COVID-19 economic shutdown created. Normally we don’t voluntarily elect to shift our unemployment to all-time highs by shutting down the economy, so with that, understand the distortions that almost every company must be facing and how that will effect earnings for the entire year and potentially beyond.

Running an Acid test with the Quick ratio enables you as an investor to see if the company were to face economic hardships whether or not they would have the assets to manage the problem effectively and remain in business. The quick ratio measures the current assets against the current liabilities, excluding all inventories. A quick ratio below 1 indicates that the company has more current liabilities than current assets. For example: If the quick ratio is .75 then for every 1 dollar of liabilities that the company has they only have .75 cents of assets. The key component to why it is that we use the quick ratio is that it excludes inventory. Biotech firms can sometimes be heavily inventory value-based. Most inventory is not able to be quickly converted to cash, so the need for non-inventory based assets is essential. This adds some cushion to the firm’s operations if a competitor enters the space. A company named Exelixis ($EXEL) boasts a quick ratio of 8.1. They make drugs which help cancer patients.

Moving to the aspect of debts, investors should only inquire in stocks that have a long term debt to equity ratio of less than one. This gives the investor a sense of how much debt in relation to equity is the company using to operate. Vertex Pharmaceuticals ($VRTX) is a $73 billion dollar market cap stock with a Long Term Debt to Equity of .08. Unless the company is sitting on an extremely large cash position, the need to maintain and shrink long term debt is important. It shows efficient management, and enables the company to pay less interest overtime. Great firms will operate in a zero long term debt setup.

Lastly, the biotech space is highly competitive, and that causes the need for companies in the space to have an economic moat to protect margins. The Return on Assets (ROA) of a company shows how profitable they are with the assets that they own. Strong companies will exhibit ROA of 10% or higher, which gives them a moat in the specific biotech or healthcare space that they operate in. Biogen ($BIIB) boasts a hefty 22% ROA.

2. Don’t chase story stocks.

The biotechnology space has been around for decades. Some of the giants today were started forty some-odd years ago, and they show how companies with lifesaving drugs or treatments can be very profitable. Consequently, the same can be said for just as many, if not more companies that said they would create lifesaving drugs or treatments- but never do. Interpret the news and findings from multiple angles and sources.

The big story in the early 2000’s and even today was ‘cancer cure’ stocks, involving companies working on the cure for cancer. While we have evolved biotechnology to better fight and even remove cancer, we have still yet to cure cancer. A lot of those companies from back then aren’t around today. Understand, this is just a word of caution because numerous companies have achieved making drugs that cure diseases or aliments. Tread lightly and do your research.

3. Understand the competition as well, and how the company is positioned.

Biotech stocks need to hold a majority of the market they attempt to operate in to maintain the margins that they produce. You as an investor must analyze the scope of the competition in the marketplace. These are companies like AbbVie ($ABBV) and Amgen ($AMGN). These are companies with ~$160 billion and ~$130 billion dollar market caps, respectively. This gives them the ability to develop strong sales accounts which also enables them to buy other companies outright if the opportunity arises.

Learn More About The Author, Brandon Smith (@BSmithTrades), at launchpadyourlife.com or on Instagram & Twitter at @LPFinancials