Research

Assessing biotechnology stocks involves use of lots of mental microscopes and magnifying lenses. But the task we’ve committed to at BioPub is not only finding new investment ideas for you in biotech before the chattering classes are all over them but also to impart to you the skill set to be a sturdy, confident biotech investor. As such, for this column I’m introducing no new companies but rather donning a wide-angle lens. The following pointers are a critique with constructive intent based on mistakes and misperceptions I see readers needing to disabuse themselves of.

(1) For reasons I don’t understand, I still see readers fretting and spending cognitive energy regarding quarterly conference calls and earnings from small cap biotechs. I’ve seen readers post, “I am interested in this stock, but will wait for the quarterly numbers before I take a position.”

May I ask why? Indeed, for small cap biotech, which is mostly what we cover, what can you possibly derive from quarterly numbers? Are you somehow not expecting a loss? Are you thinking that a loss less than predicted for a money-losing company ever facing capital crunches is somehow motivating for a buy? Why? Help me out here…..I genuinely cannot grasp what you are possibly thinking.

My number one guiding principle for how I manage the real estate between my ears is that I absolutely will not tolerate it being cluttered with irrelevant, ant-driven, busybody, nerd-worthy factoids. I hate them. I don’t give a flying faffola how many tons of coal Russia imported during the second Five Year Plan! Trends, principles, concepts, big pictures…..that’s all I travel with. That leaves me mentally agile, able to leap tall buildings over sellside analysts, most of whom have risible formulations. If you insist on driving so many nails into a board that only splinters remain you cannot and will not ever be any good at biotech investing. Don’t clutter the thread with pettiness, and more important, don’t clutter your brain with it, either.

For my columns, I utterly ignore quarterly numbers unless the company in question is large-cap and profitable. Almost none of the companies we cover here are profitable. And I have no intention of changing any habits in this regard, and will not write and publish around earnings (loss) announcements for small-cap companies.

(2) Getting up in arms about Orphan Drug Designations. These should never be a sole impetus to enter a biotech stock! Getting an ODD does incur perquisites that sweeten prospects for your company, but folks these are invariably baked into equity prices before ODD is given. It’s not hard to predict which agents for what indications will fetch ODD. Google wiki for the disease in question and look up prevalence. If fewer than 200,000 Americans have the malady, it’s going to get ODD almost invariably. The FDA, ever inertiatic, may take some time to bestow ODD, but getting it just isn’t news. ODD can be a good supporting reason to enter a stock, but heavy weather over it is totally unwarranted.

(3) Leaving profits of 25 percent or more on the table without mulling. Immediately, detractors will pounce and claim I am advocating short-term horizons and exiting after 25 percent gains. That’s not at all what I am saying. What I AM saying is that biotech is volatile, labile, swoon-prone: it’s a sector where periodic swandives are virtually assured. For certain biotechs, I admit to being a near perma-bull, but these are few. For other picks, if share price has risen by at least 25 percent, I think you should at least ask yourself: Do I ring the register and possibly re-enter later? The goal is to make money isn’t it? And I believe that for gains of more than 25 percent, your contemplation should be proportionately more intense. Are you sure of your thesis that this pick is going higher? It may be: often it is not without a cooling off. If you plan to leave 75-100 percent gains on the table, you need to be utterly cocksure. As Jim Cramer says: Bulls make money, bears make money, hogs get slaughtered.

(4) You do NOT make money in biotech holding onto losers! Admit it: $DEAD is a biotech stock in your portfolio. Biotech companies often begin brilliantly, all systems go to the best of everyone’s knowledge. Caca happens, and when it does it rarely means the original formulation of the company was wrong. What it means is that Mr. Murphy’s unknowable and unpredictable has exerted itself. If you don’t know this, if you’re uncomfortable with this, you shouldn’t be in biotech. Biotech is not retail, not energy, not banking, not real estate.

If a stock falls by 50 percent, it has to gain 100 percent to get back to even. How often does that happen? I feel there is nobility and valor in accepting your losses, liquidating, and rolling funds right back into your best pick. This is the best way to get back to even and move beyond. Guilt and remorse don’t get you far, and neither does lashing out at yourself, at me, at Alan, at Glenn, at anyone. You have my utter commitment that I will always give you my honest, heartfelt forecast…and many times that forecast is going to be wrong because the body is a black box. A patient will die of something never seen before. The FDA will have a conniption. The overall market will tank because of wayward, capricious words out of the mouths of people named “Clinton” and “Yellen.” No one at Stock Gumshoe is general manager of the universe. And believe me, when a stock I’ve enthused about gets sucked into a jet engine, you can be sure that KSS drops more f-bombs than you do.

Dump those shares of $DEAD at market open for market price and move on. Dried mud on your boots is ugly.

(5) If the CEO is a lout, you must get out. Somehow people try deceiving themselves around this important point by the false rationalization that maybe, in a given case, the CEO is mere figurehead and not important to the share price. But isn’t that ludicrous reasoning? Do you really want to have your money in a company in which the CEO makes no difference?

Part of the reason we have provided you with many hard-won interviews with biotech management is because humans are not totally divorced from their jungle primate roots, and most of us have sensing, intuitive instincts about the character of a person based on what (s)he says and doesn’t say. But if the evidence is there—-in the form of big surprises to and from the company usually—it’s time to exit. Serial wealth destroyers are legion in biotech, and often they have deceptively excellent credentials. I won’t recap here the biotech CEO’s we’ve “exposed,” but there have been several. In all those cases, exiting the stock was the wiser move.

Don’t be the co-dependent widow about to marry her fourth alcoholic husband. Don’t think you can “rehab” a CEO. CEO’s in biotech must fit the job, not grow into it. I feel it’s unwise to sit back and presume that a board will eventually knee-cap a bad CEO; they may but it’s rarely soon enough. Some CEO’s have almost incestuous relationships with boards, and many board/CEO packages succumb to downwardly-mobile groupthink. We sincerely make attempts to vet CEO’s when we float a new long idea. 85 percent of the companies we evaluate for you fail on science quality alone, but never think that excellent science absolves a company of needing an animated, imaginative, honest, technically sound CEO with real people skills to steer a company through the tight slaloms of getting a drug to market and getting a company sold. Not all CEO’s who run afoul of boards are bad ones, as many boards are dysfunctional. But if it occurs to you that a CEO is not passing muster, honor that instinct. Let us know….bring it up in the threads. Some readers may corroborate, and others may know more about the situation than you realize. You can help us enormously by being willing to play point and get CEO’s to agree to meet with us via conference call. A fish rots from the head down, and I am sure many readers have been, as I have, part of organizations literally left bereft of all honor and crippled by bad leaders. Heed those experiences and remember it is mostly futile to try changing behavior in an adult no matter how messed up that behavior is.

(6) Expecting good news from a company when news is delayed. Using your bloodhound skills, based on everything from parameters given in trial databases to corporate announcements about when enrollment began and when it was completed, it’s often possible to get a very good idea of when topline study data should be presented. When there are delays of a month or more in releasing such data, you can assume the data will represent trial failure. In biotech, absence of news is invariably bad news. News is delayed while management dump shares, conjure up fallback positions, cultivate external input on the situation to soften the blow to shareholders.

Often, biotechs with bad news marinade for many weeks and say nothing. This is never a good sign. When a biotech announces that a planned data announcement will be delayed, that’s usually a good impetus to sell shares. Good data fights its way to the fore. Companies cheer internally, and crave ways to release it at the earliest opportunity.

(7) Falling for the Linling effect. Since I began my efforts here in the winter of 2014, about once a month I’ve come across situations in which company insiders buy 5000 shares during an interval leading up to the release of bad news. They do this to pretend all is well and woo you into buying. Loyal reader Linling of Manhattan recently noticed this effect, and we’ve named it after her. In general, insider purchases are a highly auspicious thing in biotech, but Linlinging is when insiders make nugatory nibbles on shares….wee small purchases to feign interest in the company’s future. Truly good news is commonly augured by large insider purchases, often more than 6 months in advance of major good announcements.

(8) Being seduced by binary events. No single tenet of investing outweighs capital preservation in importance. The lure of a possible 100 percent or more price rise from a beaten down biotech when it unfurls great study results is powerful temptation, but experience teaches how wise it can be to have the same funds parked in a boring, large pharma dividend payer where your capital isn’t at risk.

To be fair, most binary events are not 50/50; they do not offer symmetric risk. When the risk/reward possibilities are highly asymmetric (for example, we often note that a company will rise sharply on good news but has little downside if news is bad), or when I can risk-adjust an outcome based on strength in phase 2, prevailing mood at the FDA, and competitive landscape, I make wagers in binary situations. But I do so at peril to capital and have been a loser many times. One of the realities of biotechnology is that the therapeutic apparatus has now somewhat overreached our understanding of biology, leaving us with more and more situations in which an outcome just cannot be predicted. The body isn’t quite the black box it was once…..but put the absolute value brackets around things, and it’s still very much a black box whose outputs in response to inputs just cannot be predicted. As such, I’ve seen more binary situations have bad outcomes in the last 2 years than in all my 20-odd prior years of biotech investing put together.

Remember, overall 75 percent of trial outcomes positive in phase 2 are negative in phase 3. Use extreme care in binaries, folks!

(9) Ignoring biotechs with SPAs. A SPA is a willingness by the FDA to engage in so-called Special Protocol Assessment. This is usually reserved for clinical situations where clinical trialling is extremely difficult (rare patients, highly complex patients, for example). Basically, a company can lobby for SPA, and if the FDA agrees, a pre-defined outcome from a single trial will enable the company to submit a New Drug Application. Occasionally the FDA bestows SPA not because a trial is hard to do but because the problem being addressed is acute and positive outcome so highly credible, based on sound science, that the FDA will buy in without a second phase 3 trial.

While I am sure you wouldn’t be surprised that getting a SPA causes corporate jubilation (I have argued in these pages that getting a SPA is tantamount to getting $1B in non-dilutive funding), it may surprise you that the FDA likes SPAs as well. In fact, you can really picture the company and the FDA giving each other the high-five when a SPA is settled on. Why? Because the FDA is made up of very overworked and underpaid reviewers who are highly educated and highly frustrated. A SPA lightens their load massively.

Am I saying that every company with a SPA is an automatic buy? I am not. But I am saying that companies in possession of a SPA warrant special, even lenient consideration. I am concerned that readers here don’t take SPAs seriously enough. We may need to publicize periodic lists of SPA-bearing biotechs.

(10) Failing to invoke the full power of the Gummune in your biotech investing decisions. In Arthurian legend, Merlin grants Uther a night of importunate lust when Uther agrees that whatever child ensues from his sin shall become Merlin’s. When Uther gives Arthur to Merlin, he takes the frightened boy deep into the forest, and encourages Arthur to “sleep in the arms of the dragon.” He teaches Arthur that Arthur’s prosperity shall be in proportion to the thriving he enables in the Green and Pleasant Land, and that Arthur has enormous power, including the ability to channel nature’s remarkable abilities though himself. To sleep in the arms of the dragon is to be at peace with the colossal, mystical new forces Arthur has at his disposal.

I am often a little stunned by readers who appear and post that they’ve just boldly taken a position in an unknown biotech, one that they understand poorly. Folks, you don’t have to live that way, not anymore. Don’t be shy, and don’t think that if other readers find your idea foolish that they think any less of you, as they don’t. If a stock looks appealing, air it in the threads before you leap in. Let this group kick it around. I will always give you an earnest and thorough opinion, and I do not gratuitously shoot down every idea. Some of our very best ideas have come directly from readers. You need not be secret about your stock, as you stand to benefit if others are persuaded and get in. But one of our most important tasks here is trying to keep you from losing money in bad biotech, which abounds, and I think most longterm readers would agree that we’ve provided a vital service by sounding alarms when appropriate.

I encourage you: sleep in the arms of the Gummune. We look out for each other. We answer all questions (if we don’t, post it again….occasionally I accidentally overlook a post). Write to us. Direct your question to whomever you like and trust here. Glenn Newberry, Alan Harris, HendrixNuzzles, Linling, Larry McKenna, Sogiam…..these people and others have profound insights. We have doctor and scientist readers looking for opportunities to help you. Rising tides do lift all boats….as long as you’ve got your boat in the water (get off the sidelines and get in the game). I am making a formal request: Let us hear from you. For most of us here, camaraderie is as important as profits. Female readers: it may seem like a guy’s club but it’s not. Be a part.