Growth investing really isn't growth investing without at least one biotech play, now, is it? Yes, high volatility is baked in, but recent movement in the sector points to some notable buy signs. Let's take a look.
The industry has corrected
About $2.1 billion flowed out of the biotech industry in late August and early September of 2019. It was the longest period of continuous outflows in the industry since late 2017. The Nasdaq Biotechnology Index year-to-date lows in September 2019 represented a 25% loss from its peak in 2015. But when you consider that the 10-year return of the S&P Biotechnology Select Industry Index is 470.16%, you figure a natural pullback is due.
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We're in a bullish pattern
2019 was a banner year for everything. Once biotech's September sell-off brought more balance to the industry, it began to correspond more closely to the overall bull market. Since the September lows, funds such as the iShares Nasdaq Biotechnology ETF (IBB +0.77%) and the SPDR S&P Biotech ETF (XBI +0.75%) have seen increases ranging from 20% to 25%.
It's not all about success
Individual biotech companies rise and fall quite suddenly, based on their individual accomplishments. If the Food and Drug Administration changes a rule that affects a certain medication, or a trial fails to earn FDA approval, you can expect the corresponding stock's price to gap down, even below your stop losses. (This is one of the biggest risks of investing in biotech.) In a market like this, the rise is based on pure research and development: You have people betting on seeing companies achieve something in the future rather than on the results themselves. Call it the Christmas spirit, but money is coming back into the industry generally.
What's your next move?
Unless you have specialized knowledge in the sector, it can be difficult to truly understand the biotech companies you want to buy into.
- Diversifying your portfolio is key. You can do this through one of the many exchange-traded funds that track performance throughout the industry. Depending on your risk tolerance and your confidence in biotech, you may choose a leveraged ETF to supercharge your results.
- Start early. Research companies before phase 1 testing. This gives you plenty of time to benefit from the time value baked into early speculation. FDA testing takes months, often years. Until then, investors are betting on the company itself rather than on the results of a single trial. This is exactly where fundamental investors want to be.
- Bet on management. Biotech is a small industry. Successful teams gain a reputation very quickly. Look for companies with low turnover and a history of rising returns from successful products. You may want to stay away from smaller companies with only a few products (or no products) on the market.
As with all investments, you will do better if you have a passion for the companies in the sector. The products from biotech are quite complex, and it always helps to actually like doing the research. Yes, companies here can move from a tiny market cap to eight figures over the course of a week. If you're willing to do the homework, now might be the right time to open positions in biotech.
