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Ten Rules of Small Cap Biotech Investing: Lessons From the Ugly



November 24, 2008 – Comments (1)

Those who do not learn from their mistakes are doomed to repeat them. That's why I've closely studied small cap biotechs that have failed over the last two years. If you've read my blog for the last month, you'll have read about the rules I've developed for spotting tomorrow's Ugly biotech stocks when they're still just Bad biotech stocks. Here, in my last post about Ugly biotechs, are the full set of ten rules of baby biotech investing, along with a special bonus Meta-rule that will guarantee you never again lose money investing in these companies.

Rule #1: Be fearful when others are greedy, and be fearful when others are fearful.

Stocks that are either rapidly rising or rapidly falling tend to be poor investments in this sector. If you are already invested, do not dig in your heels against reasoned criticism. Instead, seek it out and embrace it.

Rule #2: Cheap stocks get cheaper.

It doesn't matter if you bought 1000 shares at 10, or if you held out until it dropped to 1 and then bought 10000 shares. When the stock goes to 0 you lost ten thousand dollars.

Rule #3: Don’t get pulled into sucker’s rallies.

Insiders and institutions would love to hand you the bag after the lead compound has failed.

Rule #4: Don’t invest in companies with no track record of success.

Look for companies that have achieved an FDA approval, acquired and successfully marketed an approved drug, or sold a developmental program for a significant sum. Collaborations and partnerships? Not so much.

Rule #5: The only successful phase III trial is where the pre-specified primary endpoint is achieved with statistical significance.

No close calls. No secondary endpoints. No post hoc subset analysis. There’s just too much motivation for management to put lipstick on their phase III pig, prolong the course of failure, and preserve their million dollar salaries and options for a couple more years.

Rule #6: Weak interim data is a selling opportunity, not a buying opportunity.

The market awards no credit for loyalty. To avoid losing money in biotech, it is critical to have the objectivity to realize when you have made an investing error as well as the self-discipline to sell at a loss when the risk/reward ratio becomes unfavorable.

Rule #7: Do not buy a baby biotech stock just because of partnerships.

A partnership with a large pharma does not increase the likelihood that a compound will actually work. When trials fail, the large company can walk away relatively unscathed while the baby biotech has to face the music just as if the partnership never happened.

Rule #8: He who hesitates is saved.

No matter how juicy a stock looks at a depressed entry price, avoid buying until the downward trend has clearly reversed.

Rule #9: Avoid binary events.

No matter how certain it appears that a trial will be successful or the FDA will approve, surprise and disappointment are the two most common words in post-event press releases.

Rule #10: Do not abandon the previous Biotech rules based solely on a recommendation from an analyst, journalist, pundit, or anyone else.

There is no one out there who has a track record in these companies that is worth relying on. Performance in other sectors does not extrapolate to small cap biotech.

And now, as promised, the baby biotech Meta-rule. A one word rule to prevent you from doing what most other retail biotech investors are doing, which is losing their shirts.

Meta-rule for investing in small cap biotech: Don’t.

Long investments are too improbable. Short investments are too risky. Options are too unpredictable. It doesn’t matter how scientific your background is. It doesn’t matter how many hours you spent researching the company, reading every press release and 10Q, poring over the website, and checking the backgrounds of each officer and board member. The information available to you is the tip of an iceberg. Company insiders and institutions know a lot of things you don’t, and SEC regulation of small caps is about as strong as federal regulation of bank lending practices. As phase III trials start to sag under negative data, institutions are paying clinical site administrators to give them a heads up. Stocks with small floats are being pushed up and down by hedge funds looking to make a quick buck. And that’s the legal part that everyone knows about. As a retail investor, you are toast. So stay away.

Now that I’ve disclaimed all responsibility for your future losses, I’m going to devote my blog to trying to pick out the Bad and the Good biotechs that have not yet become Ugly or Great. Next post, I’ll start with the Bad. That’s where I’ll start getting hate mail from Yahoo message board trolls, but that’s the price of having an opinion on the Internet.

1 Comments – Post Your Own

#1) On October 24, 2012 at 12:31 PM, XMFRoyal (95.25) wrote:


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