Updated January 2023
Investing in biotech stocks on the ASX can be a mixed bag.
Sometimes you can really win it big. Other times you’ll end up holding a fizzer with a loss. Why are there few in between?
It’s because of how the industry is set up.
To get any new drug to market, these companies need to spend millions, sometimes billions on research and development.
Then, only after jumping multiple regulatory hurdles, more money is spent to mass produce the drug and get it out to market.
It’s incredibly cash intensive.
It’s why so many biotech stocks continuously raise money. They need a constant stream of cash to continue their research efforts.
If all turns to nought, they have to try the process all over again. Investors sell their shares, and the company treads water before they can raise more cash.
But if the company becomes a major success, with sales protected by patents, let’s just say it’s possible that you won’t need to find another winner for a while.
Before we go any further, let’s take a look at the two different biotech stocks.
The big and small of biotech stocks on the ASX
CSL [ASX:CSL] is a well-known Aussie brand.
They’re a global leader in immunoglobulins (antibodies) for a whole bunch of disorders and diseases.
CSL generates billions from their products. And about 20% of sales turn into profits.
While the biotech big-name was generating healthy increases over the past few years leading up to the COVID-19 pandemic (and all that negatively encapsulated), the business has experienced something of a knock in the flow-out of that time.
Not to mention, the ongoing political, operational, and cost-of-living disruptions that have had varying impacts across the board.
Take a look at the following figures:
| 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | |
| ROE | 46.6% | 46.7% | 46.7% | 47.7% | 41.1% | 35.7% | 31.9% | 19.6% |
| ROIC | 28.0% | 21.6% | 22.1% | 23.2% | 24.3% | 21.6% | 21.2% | 18.1% |
Source: Marketscreener and CSL
CSL’s return on equity (ROE) is saying the business was generating around 19.6 cents on every dollar of shareholder money by the end of the 2021–22 financial year.
Pre-pandemic — and let’s say, in better economic times — the business was experiencing a high of 47.7 cents a dollar (2018) on shareholder money.
Return on invested capital (ROIC) just adds debt to the mix. And even with debt, CSL generate about 18 cents on each dollar invested.
When returns like 2015–2021 pop up, there are lots of people quick to snap up returns. And despite the recent dip, CSL’s overall position remains strong, for the most part — for now.
So why haven’t competitors come in to spoil CSL’s party?
To explain, we need to know a little about the pharmaceutical industry.
Companies like CSL spend millions, sometimes billions to develop and test drugs. And because they spend such enormous amounts getting these drugs to market, society believes they should be entitled to any future profits.
It’s why we have patents. These patents give holders the right, and usually no one else, to produce something.
So while many competitors would like to share in CSL’s profits, they cannot by law.
So as long as CSL continues to develop highly profitable drugs, investors will be more than happy to buy the stock.
In 2018, CSL’s stock passed the $200 mark. A single CSL share could trade for more than 44-times earnings (a P/E of 44).
By the end of 2022, CSL’s shares were hovering around $285.
Of course, the whole industry isn’t full of CSL’s. There are plenty of more speculative bets as well.
An example of a more speculative bet in the pharma industry is small biotech stocks.
These stocks are usually smaller than the global pharma’s. Some, maybe even most, might not be generating a profit yet.
The goal for these companies is to develop a drug which sees earnings skyrocket.
The sad truth is a lot won’t achieve their goal. Only a few biotechs really hit it big.
But don’t be fooled into thinking that it’s easy to make money in this industry.
Venturing into the small biotechnology firms is one of the riskiest bets to make (hence the huge potential). Sure, you might find a stock working to develop drugs within a billion-dollar industry.
Yet for most companies there are just too many hurdles to mount. Cash, stellar results, regulatory approval, market acceptance, and long-lived patents.
These are all variables biotech’s need to get right.
As you can imagine, for every winner there’s likely another 10 stocks that fall all the way to zero and you could lose some or all of your investment. So you should never invest more than you can afford to lose in this sector.
So how can you tackle this market without losing your shirt?
How to identify quality biotech stocks on the ASX
First, decide which kind of biotechnology stocks you want to look at.
If you’re more for the CSLs of the world, then its business as usual. Look for highly profitable companies with long patent lives and a pipeline of new drugs that are solving big problems.
These kinds of companies won’t always be cheap. And why should they be? They’ve got patents to protect their sales and potentially more leading drugs coming to market.
Of course, you’ll have to make up your mind about the value of the business i.e., is it worth buying at today’s price?
On the other hand, if you’re looking at tiny biotech stocks, profits aren’t all that important. Its why many make losses for years on end.
Instead, you should be looking at the problems these biotechs are trying to solve. Maybe they’re trying to tackle an immune disease or cancer.
It would be important to also see how much time and money the company has spent on these projects already.
Are trials yielding promising results, or is the company spending millions of dollars and seeing nothing in return?
It’s also worth noting the company’s timeline. When will trials be scheduled? Will they submit results to regulators for approval soon or are they currently trying to progress to human trials?
These are all important questions you need to find out.
Usually, a little research will reveal if these tiny stocks are onto something, or if they’re fighting a losing battle.
If you find something close to the former, it might be worth thinking about commercialisation. How will this tiny stock handle the launch of its drug? Will they do it themselves? If so, they’ll need a whole lot more cash to get the job done.
Or are they planning to licence out their process/drug/discovery? If so, then they might be able to generate sales a lot quicker.
Of course, the numbers are important. But as you’ve seen, betting on the little guy is far more subjective.
If you’re not comfortable with that, then maybe sticking to a CSL type stock is more your style.
Whichever stock you do end up choosing, please know there will always be risks involved.
When dealing with unknowns, like which biotech stocks to watch …diversify
When you’re faced with multiple unknowns, diversification can actually come in handy.
This rule applies not only to tiny volatile biotechs that can double one month and half the next. Even companies like CSL are not risk-free bets.
I’m not about to predict when CSL will fall to zero, if at all.
But the value of CSL can fall for any number of reasons. What if they cannot develop any new blockbuster drugs after many of their existing patents run out?
What if a competitor comes out with new, improved drugs which makes CSL’s core portfolio obsolete?
Such scenarios don’t happen every day. But there’s still a chance it could happen.
It’s why owning a group of biotech stocks can help prevent losing a sizeable portion of your investment.
There’s no doubt about it, the world of biotechs can be thrilling and exhausting. But always do your own research and be mindful of the risks involved.
