Finding Healthy Healthcare Stocks
Why Are Health and Biotech Stocks So Appealing, Yet So Risky?
Healthcare and biotechnology stocks could potentially generate spectacular returns, but watch for the big bad wolf in the form of excess exposure to risk.
If you are looking for potentially rewarding risk versus return situations, biotechnology and healthcare stocks are probably as good a place to look as any. Historically speaking, whenever the topsy-turvy world of financial markets produced various degrees of derailment, investors flocked to sectors that are considered as “safe havens,” among which are also healthcare and biotechnology.
The logic behind this reasoning is simple—it is a fact of life that at some point, everyone gets ill and needs to call a doctor or a pharmacists. It is also a fact of life that there will be a number of people who will need much more than that, like a surgeon, a therapist, a nurse, a prosthetic, a dialysis machine, artificial lungs, blood, and who knows what else. This is why selecting the “right” healthcare stock could potentially bring huge rewards, simply based on the laws of supply and demand, but only as long as investors understand that such stocks can also wreak one heck of a "risk hurricane."
Risks Involved When Investing in Healthcare Stocks
What kind of risk are we talking about? For starters, it can take almost a decade and close to a billion dollars just to bring a single drug to the market. Here is another piece of rather depressing statistics—only about ten percent of all drugs that have gone through preclinical trials have actually reached clinical trials. And from those that did, only about 60% have made it past all three phases and received the coveted stamp of approval from the Food and Drug Administration (FDA). (Please note that more statistical information concerning the drug approval policies and procedures is available on the FDA's official website.)
With such statistics to deal with, who in their right mind would even bother investing in healthcare and biotechs? Well, investors who know where and what to look for would! No one can diversify away all components of risk, especially when dealing with such volatility-prone sectors, but there are always ways to alleviate risk, at least to some extent.
Protecting Your Investment in Healthcare Stocks
For example, when investigating healthcare stocks, make sure you go through the following checklist:
- How many drugs are already approved and on the market?
- Does the company have an extensive product pipeline?
- How many drugs in clinical trials are in late stages and what are their approval prospects?
- Are there any partnership and collaboration agreements in place with other players in the sector?
- Does the company's management run a fiscally tight ship and how much cash is there for capital and discretionary spending until the company can reach profitability?
There is one more thing to consider. Big Pharma moves very, very slowly. When companies get as big as, for example, Pfizer Inc. (PFE/NYSE) or Novartis (NVS/NYSE), Wall Street perceives them as mere cash cows with often little upside momentum. Which is true, when a company gets to be that big, it is very difficult to find room for significant growth.
Thankfully, the field is also littered with growth-stage companies that may already have a drug marketed on the shelves of your friendly neighborhood pharmacist. There are also mid-size biotechs that have rich drug pipelines, lucrative collaboration agreements, and plenty of cash in their coffers.
Investors, however, should always remember that the moment something goes wrong in clinical trials, whether it be only a small hurdle, or a six-feet tall brick wall, it could cost you your entire investment. So, by all means, open yourself up to possibilities in the healthcare industry, but never lose sight of how much risk you are willing to take on.
To help you along the way, we recommend “arming” yourselves with a few tools of the trade, such as how to utilize the capital asset pricing model (CAPM) when evaluating expected returns of securities, or how to evaluate a stock’s risk with its beta, or what can be learned from the Price-to-Earnings (P/E) Ratio and PEG Ratio.
