Biotech, a sector that can make or break your portfolio. But first, what even is “biotech”?
In a nutshell, biotech is the use of living organisms to make products or run processes. People know biotech best for the vital role it plays in the field of medicine. However, biotech is not limited to just medicine. It finds application in other areas such, as food and biofuels. Biotech combines many fields into one including biology, physics, chemistry, mathematics, and of course technology.
What helped this sector really take off was the discovery of DNA in 1953. This allowed tremendous advances in the field of biotechnology. Further, a historical milestone which ended up defining this entire industry was a supreme court case in the 1980’s. There, the court ruled to allow for patenting of genetically modified organisms. This means that intellectual property will always be in the limelight for this sector. From an investors standpoint, that sounds pretty exciting. However, the sector is full of complications which make it difficult for investors and Wall Street analysts to understand.
Profiting in biotech
Biotech has exceptionally high research and development costs, complimented with very little revenue in the years of development. Because of this, many biotechnology companies must partner with larger ones to complete product development. Over the past several years, a select few companies have conquered the sector. Smaller companies still have the potential to produce a product that makes them a king of their niche as well. The race to be first at a groundbreaking biotech product is what drives growth in this industry. This is especially common when talking about health care. Since drug development is an important aspect of biotechnology, understanding the process of approval of drugs by the FDA is critical. The Food & Drug Administration (FDA) Approval Process breaks down into three phases.
- Phase I is approximately 1 year. During this time span, testers administer the drug to 20-80 healthy individuals. Phase I determines the dosage and the safety of the drug. Phase II is approximately 1-3 years.
- During phase II, 100-300 patients that suffer from a disease or condition receive the drug. This phase determines effectiveness, along with any potential side effects.
- Phase III is approximately 2-3 years. Here, 1000-5000 patients suffering from disease or condition receive the drug. This phase monitors side effects brought on by long term usage. This is by far the most stringent and rigorous phase. Some of the patients receive the drug, and the others receive a placebo (like a sugar pill) to determine effectiveness.
A brief history
Now that you know about the structure of the biotech industry, let’s take a look at the historical performance of the sector as a whole.
If I were to summarize this chart in one word, it would have to be “volatile”. This sector is known for its volatility, which some investors love, and others hate. The risk/reward for this specific sector is high, which attracts everyone from retail investors to hedge funds. Around 2001, you notice an obnoxious spike in the performance of the sector. To give you an idea of how big this spike was, I’m going to screen it next to the Technology sector to give you a reference.
I was surprised to see that the biotech bubble was over twice as large as the tech bubble in 2001. That was really odd to me, because 2001 and the turn of the millennium is known for the tech bubble, not the larger biotech bubble. Through further research, I also saw that Science and Nature magazines published the human genome sequence, making it possible for scientists all over the world to begin researching new treatments for diseases that have genetic origins, such as cancer, heart disease, Parkinson’s and Alzheimer’s. I’m sure that was a significant factor in the artificial inflation of the biotech sector at that time.
Now, let’s fast forward to 2009, and see how the biotech sector has performed in more recent times. As you can see below, the biotech sector was nothing special. It showed similar returns to the S&P 500. This changed in mid-2013, when the sector began to outperform the S&P. It began churning out some returns, but became very volatile shortly after. This was followed by some more gains mixed with volatility.
Then, on September 21, 2015, the sector was hit hard not by economic implications, but a tweet. At the time, Presidential candidate Hillary Clinton was favorite to win. Her words really mattered, especially to speculators. She tweeted, “Price gouging like this in the specialty drug market is outrageous. Tomorrow I’ll lay out a plan to take it on. -H”. This tweet sent the sector into a downward spiral. It brought up the multi-sided argument of drug pricing, which put the sector in the spotlight for all the wrong reasons. Since then, the ethical vs. business argument has dominated the spotlight, raising questions over the future of the biotech industry and what future revenue growth may look like if legislation comes into play which limits the pricing of certain drugs.
For now, the biotech industry looks like a coiled spring to me with a few anomalies. This spring could be ready to go up, or down depending on what the future holds for biotech. The complications of “repealing & replacing” Obamacare has also put some pressure on these stocks. Compared to other stocks and sectors which investors see a less bumpy road for, biotech stocks seem unfavorable.