The Secret to Successful Investing in Biotech

Have you ever had a stock jump 30%, 50% or 100% in one day?

It’s an amazing feeling. It doesn’t happen often, but when it does, it’s almost always in the biotech sector. In fact, last Wednesday, Jasper Therapeutics (Nasdaq: JSPR) soared 89% in one day.

The reason it’s biotech companies usually making these giant moves is no other sector has such important catalysts that can instantly revalue a company.

For example, let’s say a company is trading at 15 times earnings and reports a blowout quarter, shattering earnings estimates. Even if the market assigns the stock a higher valuation, it probably won’t be much higher – maybe 16 or even 17 times the new earnings figure.

But when you have a biotech company with no earnings or revenue, because its drugs are still in clinical trials, strong data or a Food and Drug Administration (FDA) approval can completely change the picture.

Wall Street values biotech stocks based on the probability of a drug getting approved and reaching the market. After strong clinical trial data or – obviously – FDA approval, those odds can increase significantly and, as a result, the valuation of a company can rise sharply.

For example, Compugen (Nasdaq: CGEN) has a market cap of about $500 million. The company has no revenue, as it has no products on the market.

Compugen has four drugs in its pipeline for the treatment of various cancers, including ovarian, breast and colorectal subtypes.

The company is partnered with Bayer (OTC: BAYRY), Bristol Myers Squibb (NYSE: BMY) and AstraZeneca (Nasdaq: AZN) on several studies.

If its Phase 1/2 trial with Bristol Myers Squibb studying Compugen’s COM701 in combination with Bristol’s Opdivo shows strong results in breast cancer, an indication for which Opdivo is not yet approved, that should send shares of Compugen soaring, as it makes it more likely that COM701 will be approved in the future.

There’s still a long way to go until that happens, but the odds will have improved in Compugen’s favor.

Additionally, the more a drug is proven safe and effective, the more likely the company gets acquired. This is because it can be cheaper for a large biopharma, like Bristol Myers Squibb, to simply buy a promising drug through the acquisition of its company than to develop a new drug.

In this example, it wouldn’t be far-fetched to think that Bristol Myers Squibb (or any other large pharma) could offer $1 billion to acquire Compugen. Considering that it takes roughly $1 billion to develop a new therapeutic, buying Compugen for $1 billion would give the acquirer four shots on goal.

If Compugen is not acquired and continues to develop its drug candidates and those drugs have promising clinical trial data, it would not be surprising at all to see the stock trade higher and higher.

There are plenty of companies with multibillion-dollar valuations that have no drugs on the market yet.

Celldex Therapeutics (Nasdaq: CLDX) has a $2.3 billion market cap with three drugs in early-stage clinical trials.

Nektar Therapeutics (Nasdaq: NKTR) trades with a $3.2 billion valuation and has four drugs in clinical trials – some of them in late-stage trials, so they’re closer to potential approval.

These are just a few examples to show you the potential increases for some biotechs. If Compugen grew to the size of Celldex, that would be more than a 300% gain. And it’s not like Celldex is Pfizer (NYSE: PFE). Celldex has no products on the market.

Imagine what would happen to the valuation of Compugen, Celldex or Nektar if one of their products got approved and started selling.

The numbers would get very big in a hurry.

Biotech stocks, particularly the small ones, come with higher risk, so be sure you can handle it. But the bottom line is that the potential rewards in biotech are enormous and larger than those of any other sector in the market.