As any experienced investor will tell you, the stock market is full of ‘sectors’. Loose categories that group up companies which share a common theme.
For instance, on the ASX, our biggest sector is materials (resources). Our local exchange is chock-full of companies looking to dig into the earth for something valuable.
This is just one sector though…there are 11 in total. At least, according to the Global Industry Classification Standard (GICS). A classification that most of the world has agreed upon.
I won’t bother going through the list in full. You can look that up for yourself. But, suffice to say it’s a very broad and very general list. As you delve deeper though, you begin to find sub-sectors. Categories that aim to add a little more specificity to the stocks within them.
And today, I want to talk about one of those sub-categories, one that we have brought up in the past. As you’ve probably guessed, it is biotechs. The title may have given it away…
Anyway, if you’re a little hazy on what biotech means, it’s simple. Basically it’s just a label for companies that work with living systems or organisms.
More often than not though, if someone is talking about a biotech stock it’s probably got something to do with health. Generally speaking, biotechs are all about finding new ways to keep us all alive and well.
They can be some of the most fascinating companies to learn about. More often than not, they are at the forefront of medical research. And when they make a breakthrough it’s usually a very big deal.
That’s the whole appeal of investing in biotechs. It’s an industry full of stories that fit the ‘overnight success’ narrative. But, there are plenty of examples of overnight failures as well.
Biotechs are definitely some of the riskiest and most volatile stocks on the market. And the main reason for this risk is simple: clinical trials.
Proof of concept is vital
I’ll put it bluntly…when it comes to medicine, we (as a species) are pretty dumb.
Don’t get me wrong, modern medicine has come a long way. Open up any history book and you’ll be horrified by the treatments of the past. Luckily most of those horrors are now behind us.
But, there is still a lot that we don’t know about our bodies and how they work. If we knew everything, there probably wouldn’t be a need for a biotech sector at all.
That is their main role. They’re constantly trying to find out more about our bodies. How it works, how it reacts to certain things, as well as how to keep it healthy.
Fortunately, we’re rarely short of new ideas. Smart people in labs all over the world are constantly finding new ways or things that could help us. But ideas are one thing, proof is another.
In order to get a drug on the market, you need to show that it works. And the only way to do that is through clinical trials. A process that is long, costly and not guaranteed.
No matter how promising a new lab breakthrough may look, if it doesn’t pass the clinical test, it’s no good. That’s why a biotech’s share price will often shoot up or down rapidly. All that matters is the result of the trial.
Take this anecdote from the MIT Technology Review for instance:
‘In January 1977, five landmark health surveys, led by the famous Framingham Heart Study, reported a “striking” revelation about HDL cholesterol—a.k.a. the “good cholesterol.” The higher the HDL in a person’s bloodstream, researchers had found, the lower the risk of heart attack. This held true for every age group and both sexes. In fact, HDL was the only reliable predictor of heart disease risk in people over 50, which is the age group people who have heart attacks are likely to fall into.
‘In observation after observation ever since, the relationship between HDL cholesterol and heart health has been so outrageously robust it’s hard to imagine that HDL doesn’t play a fundamental role in preventing the disease process. This has led drug companies to spend billions of dollars developing and testing HDL-raising drugs, with the expectation that heart attacks will be prevented, lives saved, and investments recouped many times over.’
It’s the kind of lead that every biotech dreams of. An insight that could help save millions of lives and make the drug companies billions of dollars.
But it didn’t.
All the HDL-raising drugs were a bust. They weren’t improving heart health at all. All that time and money was effectively wasted.
Is there a way to make biotechs less of a gamble?
What it all boils down to, as the Technology Review themselves note, is simple: Correlation does not imply causation.
Or, in layman’s terms, just because two things seem related does not mean that one causes the other. Sometimes it really can just be chance. And as the Technology Review comments,
‘Arguably, the most important question in all of medicine and public health is how to tell which correlations are causal and which are not.’
This is the bane of every biotech in existence. This one distinction could be enough to derail years of hard work. A factor that often makes these biotech stocks the ultimate gamble.
Perhaps more importantly, if you really want to extrapolate the issue, you could even say this problem is costing us human lives. Every time a clinical trial ends in failure, that’s time and money that could have been spent potentially developing a product that works.
It’s a grim way to look at it, but it’s hard to argue against. At the same time though, we can’t give up on potential research.
It would be easy to say that we should stop searching for new drugs altogether because they may not work. But, that’s very short-sighted and no one is going to go along with that thinking.
Instead, what we really need are better outcomes, or rather, more certain outcomes. We need to take the chance out of clinical trials.
Now, you might say that’s impossible. Technically you are correct, but that might not be the case for much longer.
Researchers may have finally found a way to make biotechs less of a gamble. But, I’m all out of time and words for today.
You’ll have to wait for tomorrow to find out what it is.
Editor, Tech Insider
PS: If you’re looking to add a few promising biotech punts to your portfolio, don’t invest a cent until you read our tech expert’s Harje Ronngard free report ‘The Key to Spotting Breakout Biotech Stocks‘.