How to Evaluate Small Cap Biotech Stocks
Many of the best small cap biotech stocks are boom-or-bust opportunities. No other sector sees companies go from zero to hero quicker! All it takes is one groundbreaking clinical trial and a drug patent to send a small cap biotech up to the big leagues. The trick to getting in on the ground floor is thoroughly evaluating any small cap biotechs you choose to invest in.
Evaluating any biotech requires its own investment of time. It goes beyond looking at a balance sheet or a stock chart. To position yourself for success, you need to understand the biotechs you’re investing in. What are their areas of focus? What do their pipelines look like? Are their therapies novel or remedial? Is there interest from hedge funds? These questions and so many more lay the foundation for an evaluation process that’s anything but simple.
Here’s a quick overview of how to evaluate the best small cap biotech stocks. Take these factors (at a minimum) into consideration as you vet a potential biotech investment.
Pipelines and Partners of the Best Small Cap Biotech Stocks
The first and most important thing any biotech investor needs to do is head over to the company’s website and look at its drug pipeline. What drugs, devices, therapies or other marketable products is it developing? Is anyone helping it develop them?
A biotech company without a product pipeline or partnerships isn’t one you want to invest in. The drug pipeline is the key to growth. A promising new drug could take off and become a new must-have treatment for a serious illness. The company that holds the patent will profit significantly.
Partners are also worth considering. Many bigger pharmaceutical companies will commit to a smaller company to do the legwork for drug development. Look for companies with big-name partners who’ve endorsed them.
While you’re checking the drug pipeline, see how far out from marketability the company is. Some companies have 20 drugs in their pipelines, but they’re all in preclinical (research) stages. Conversely, a company might have three dugs that are all nearing the end of Stage 3 clinical trials – meaning they’re almost ready for market. The further along a drug is, the more viable it is. Lots of drugs fizzle out in Stage 1 or Stage 2.
Also, look to see if any drugs have FDA weight behind them in the clinical stage. Sometimes the FDA will “fast track” a drug with promise, which is a strong sign for bullish investors. And drugs that receive emergency approval are as good as approved when they receive that status, though they may still be in development.
Cash to “Biobucks”
“Biobucks” is an industry terme for the earning potential of the drugs in a company’s pipeline – specifically, how profitable they could become after meeting certain milestones. There are a lot of contingent factors to consider, including development terms and conditions. Here’s an example:
XYZ Biotech just signed a $5 billion deal with a larger company to produce a drug for patients in renal failure. The terms of the deal include $2 billion delivered upfront, to finance preclinical research and development. $1 billion disperses after the company completes Stage 3 clinical trials. The remaining $2 billion is guaranteed only if the drug is viable and reaches 5,000 distributed doses in the first fiscal year after deployment.
The easier and more attainable the stipulations are, the more “biobucks” a company has. Really, think of them as unrealized gains. The more biobucks promised to the company upfront, the better the sentiment for the development process is. When researching small cap biotech stocks, research which companies they’ve brokered deals with, their values in biobucks and what the criteria for obtaining them are.
Hedge funds don’t typically invest in small cap stocks unless they show strong growth signals. Institutional activity in a small cap biotech usually means the bigger players see imminent promise. While it’s not a clear indicator of a company’s trajectory, institutional interest tends to correlate with share price increase. For retail investors, copying the big guys often means taking a hot tip from investors with more resources to research and evaluate a stock.
The talking heads on TV are worth listening to when they all start jabbering about the same stock. Sudden mentions of a small cap biotech in between all the chatter about blue chip darlings is a strong signal that other people are paying attention to what could be a gem. Don’t trust analysts blindly. Instead, start looking deeper into what they’re talking about and see whether the positive sentiment aligns with all the other factors we’re outlining.
Beware Biotechs With Suspect Activity
The last – and potentially most important – factor to consider is charting activity. Regular spikes and dips in the price over a period of a few weeks are a bad sign. Pump-and-dump schemes are widespread in the biotech sector. Why? Because so few people understand how to evaluate these stocks. What might look like a disagreement about fair market value could really be investors inflating share price to take gains.
If a company hasn’t put out any news recently, its stock should pace the broader indexes. If the chart is popping and falling in regular intervals, stay away—unless you’re prepared to hold the bag long term. Similarly, look at trading volume to see if it’s the same shares changing hands over and over again.
Evaluate With Confidence
You don’t need to be a scientist to understand and evaluate biotech companies. Pay attention to the fundamentals and do a little digging into what they’re focused on. It doesn’t take long to determine whether a company is on the cusp of something powerful or is a dead-end stock destined to languish. For the best small cap biotech stocks, a little research beyond the numbers goes a long way in picking a winner.
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