Shots in biotech's arm

E*TRADE Securities2

07/20/17
Think the long wait for a conclusion to health care reform has dampened investor spirits about the health care sector this year? Think again. Investors haven’t been idly flipping through old magazines in the waiting room—the S&P Health Care Index1 is up 15.88% in 2017. And in biotechnology, several recent developments in that corner of the health care market have given it a little B12.

Rising in wait

For its part, biotech is no stranger to lengthy waits—it can take a decade, or longer, for a new drug to make its way from lab to pharmacy. And those lead times are one of the reasons that make biotech stock performance particularly prone to news flow.

Following some tough talk about drug pricing during the 2016 presidential campaign, investors may have been left wary of what could be in store for biotech under the new administration. So it may be news to some that biotech has been a notable market leader this year, and a key player in the overall health care sector’s strong 2017 performance. In particular, the Nasdaq Biotech Index2 is up a robust 20.50% year to date.

Nasdaq Biotechnology Index year-to-date performance

Source: Bloomberg

Market observers point to the following drivers behind that recent performance, and as possible catalysts for future growth: 

  • Easing regulations. In June, investors seemed energized by reports of an executive order in the pipeline that focuses more on relaxing industry regulations than calling on manufacturers to lower drug prices.3 How that executive order proceeds will likely continue to draw the investment community’s attention. 
  • Cancer progress. Positive clinical trial data from cancer-focused mid-cap biotech players recently helped raise expectations for the possibility of mergers and acquisitions (M&A).4 Should deal activity arise, it could create investment opportunities for some of the larger biotech firms, which rely on M&A as an important source of growth.    
  • Expedited approvals. Some analysts point to a higher rate of drug approvals as boosting biotech this year. One of the goals of the 21st Century Cures Act, passed last December, was to expedite Food and Drug Administration (FDA) approval processes and increase innovation. Thus far, it seems to be working, as the FDA has green lit 23 novel drugs in 2017, compared to 22 in all of 2016.5   

Potential side effects

Market dynamics can sometimes make investing in biotech companies feel like an obstacle course. Research and development is not only lengthy, it’s costly—to the tune of $2.6 billion on average for a single drug that makes it to the market, when factoring out-of-pocket and time costs.6 These variables can make valuing biotech companies a challenge, forcing the market to rely less on fundamental analysis and more on news flow pertaining to the FDA, approval processes, and clinical trial data. Of course, also never far from biotech is the potential for new regulation. 

Investors interested in exposure to biotech may want to consider that the odds are stacked against companies getting their products approved for distribution, to say the least. It’s estimated that only about 10% of companies ever get their products to the clinical trial process.7 So, as is true with all industries, diversification can help reduce concentration risk.         

 

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1. As of July 18, 2017, according to https://us.spindices.com/indices/equity/sp-500-health-care-sector. The S&P 500® Health Care Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS®) health care sector.

2. As of July 18, 2017, according to https://www.bloomberg.com/quote/NBI:IND. The Nasdaq Biotechnology Index contains securities of Nasdaq-listed companies classified according to the Industry Classification Benchmark as either Biotechnology or Pharmaceuticals which also meet other eligibility criteria.

3. Kaplan, Sheila and Thomas, Katie. “Draft Order on Drug Prices Proposes Easing Regulations,” The New York Times, 20 Jun. 2017. https://www.nytimes.com/2017/06/20/health/draft-order-on-drug-prices-proposes-easing-regulations.html

4. Grant, Charley. “The Dark Side of Good News in Biotech,” The Wall Street Journal, 19 Jun. 2017. https://www.wsj.com/articles/the-dark-side-of-good-news-in-biotech-1497886898

5. “Biotech Stocks Facing FDA Decision in July,” Business Insider, 29 Jun. 2017.  http://markets.businessinsider.com/news/stocks/Biotech-Stocks-Facing-FDA-Decision-In-July-1002133192

6. DiMasi, Joseph A.; Grabowski, Henry G.; Hansen, Ronald W. “Innovation in the pharmaceutical industry: New estimates of R&D costs,” Journal of Health Economics, May 2016. http://www.sciencedirect.com/science/article/pii/S0167629616000291?via%3Dihub

7. “Clinical Development Success Rates 2006–2015,” Informa, Amplion, and the Biotechnology Innovation Organization, 25 May 2016. https://www.bio.org/sites/default/files/Clinical%20Development%20Success%20Rates%202006-2015%20-%20BIO,%20Biomedtracker,%20Amplion%202016.pdf

Note: The focus on health care–related securities increases exposure to the risks associated with the health care–related sector, including changes in laws and regulations, lawsuits and regulatory proceedings, patent considerations, intense competition, rapid technological change, and the potential for undesirability.