Investing in the Biotech Sector: 5 Elements To Consider
Mar 31st, 2009 | By Marc Lichtenfeld | Category: FeaturedWhen Arena Pharmaceuticals (Nasdaq: ARNA) released positive Phase III data on its obesity drug, Lorcaserin, many people expected shares to take off. After all, the company’s press release on Monday confirmed that the drug had proven to be safe and effective.
Why I Did Not Recommend Arena Pharmaceuticals
But in a classic example of just how volatile and unpredictable the biotech sector can be, the stock slumped 28% instead. While the news was good on the surface, the problem was that Lorcaserin didn’t help patients lose 5% more of their body weight than placebo. The 5% figure is a guideline that the FDA uses for approvability – and investors punished the stock for not meeting that requirement.
Let’s dig into the story and apply the lessons from it to investing in the biotech sector…
Investing in the Biotech Sector Is Not Easy
Investing in the biotech sector is not easy.
In fact, I’d argue that it requires more due diligence than just about any other sector, simply because of its unpredictable nature and that the science sometimes can’t match people’s hopes for a drug. And when there’s a lot of buzz around an important drug that tackles obesity – one of America’s leading healthcare problems – it can exacerbate the fallout.
Even the very best investors in the biotech space have had stocks blow up on them after bad clinical trial data. It’s part of the business. As I’ve said here before, when you try to capture the potential enormous gains that biotech has to offer, you take on some extra risk.
With Arena Pharmaceuticals, that risk outweighed the reward – and I outlined my reasons why at the Investment U Conference in St. Petersburg, Florida just this past weekend.
How to Find Winners In The Biotech Boom
As I explained in my workshop, “How To Find Winners In The Biotech Boom,” there were a few things about Arena’s story that I found risky…
- Competition: Whenever possible, I like biotech companies with drugs/devices that face little or no competition. But several other companies, including Vivus (Nasdaq: VVUS) and Orexigen Therapeutics (Nasdaq: OREX), have obesity drugs that are in late-stage development. So even if Lorcaserin was effective and Arena had “first mover” advantage, it would likely face competition in the near future.
- Results: In Phase II trials, Vivus’ and Orexigen’s data was stronger than Arena’s. Moreover, Vivus has already shown effectiveness in one Phase III trial. Results from two more are expected this summer.
- The Fen-Phen Issue: In 1997, popular weight-loss drug fen-phen was withdrawn amid reports that its caused heart valve disease. So when Lorcaserin was described as the chemical cousin to the drug, the relationship didn’t sit well with me.
In short, the possible safety issue and the potential for better drugs to enter the market soon meant the reward wasn’t high enough to justify taking on the substantial risk.
And when we’re talking about biotech, avoiding unnecessary risk is critical. You can be sure that if I decide to take on additional risk, you can be sure that the potential reward will be very significant.
Investing in the Biotech Sector: A 5-Step Stock-Picking Method
Before investing in the biotech sector, I use a five-step stock-picking method. Here’s how I pick healthcare and biotech stocks…
When I select companies for my healthcare service, Access, I rely on my F.I.R.S.T. research methodology, which focuses on Financials, Interviews, Research, Safety, and Timing.
I spend a tremendous amount of time separating the companies and stories that merely make interesting reading from those that go one step further and make solid investments.
Many of the companies I recommend are well under-the-radar. Don’t expect to hear them being pumped on CNBC, Internet message boards, or in the mainstream financial press (yet).
Most of them are in what I call the “gathering period” – when influential investors, insiders, and sector specialists are accumulating substantial positions ahead of breakthrough news and/or product announcements.
While these catalysts often lead to short-term share price gains, more importantly, they set the stage for substantial moves higher over the intermediate and longer-term.
Don’t get me wrong… Arena was an appealing story. But there are lots of exciting stories in the biotech sector. And the company failed on a couple of major issues.
When investing in biotech, understand that blowups happen. But also know that it’s a sector capable of producing gains of 10,000% or more. Just ask the investors who bought Amgen (Nasdaq: AMGN), Celgene (Nasdaq: CELG) and Biogen Idec (Nasdaq: BIIB).
Even in this crummy market, Access subscribers are sitting on current gains of 97% (on a position initiated in October) and 23% (in just one month). You just have to know where to look.
Hoping your longs go up and your shorts go down.
Source: Investing in the Biotech Sector: 5 Elements To Consider
You know, it doesn't take a background in biotechnology to read a
study. I would recommend taking a look at the actual results of the
test. What they show is that a drug with basically zero statistically
significant side effects causing a basically unaided 5% drop in body
weight for half of the subjects. That fact in itself is pretty
amazing, and is definitely unparalleled in the results of the drug's
competitors.
The only serious contender for a weight-loss drug is Qnexa, which
showed an eye-popping 7% spread over the control group in it's most
recent data set. But it also showed side effects that are likely to
induce patients to discontinue use and to cause some concern among
physicians in prescribing it. Parathesia (which is your skin going
numb and prickly for an extended period of time), dry mouth and
altered taste were reported at 20%, 18% and 15%, repectively (placebo
3%, 0%, 0%). So there are obvious, dramatic, uncomfortable side
effects. What is bizarre to me about the recent market movement is
that this drug, which is not a new drug, but an amalgam of two already
available drugs (an amphetamine and an anticonvulsant) shows
worryingly high incidence of subjectively serious side effects, has
been assumed to be the stronger market candidate. Given the public
perception of diet drugs, and the serious health risks involved in
giving a chemical speedball to overweight people and then telling them
to exercise on a nutrient restricted diet, I would stake the house on
the fact that when push comes to shove, neither doctors nor the
general public is going to give a very warm reception to Qnexa,
despite the impressive weight loss attached to treatment therewith.
Lorcaserin on the other hand, as mentioned above, just came back with
essentially zero side effects. The only side effect which exceeded a
2% difference with the side-effects reported by the placebo group was
a 7% difference in patients reporting headache. The rest of the
reported side-effects were either less than 2% separation or actually
had the placebo group reporting in high percentages than the
experimental group.
Additionally, there is the issue of subject mortality within the
control group:
"The Week 52 completion rate was higher for patients on lorcaserin
(55.4%) compared to those on placebo (45.1%). The difference is
primarily attributed to higher discontinuation rates for "Subject
Decision" (19.2% lorcaserin vs. 27.7% placebo), which includes "Lack
of Efficacy" (1.7% lorcaserin vs. 5.5% placebo)."
For those of you who haven't taken intro Stats classes, what this says
is that the people in the control group dropped out of the study at
WAY higher rate than those in the experimental (lorcaserin) group.
"Subject Decision" means that they dropped out because they wanted to
and "Lack of Efficacy" means they dropped out because they weren't
losing weight. Essentially what this means is that significantly more
people in the experimental group WERE NOT SEEING RESULTS, and
accordingly dropped out. Thus, the very people who were not losing
weight, whose lack of results were the result of being given the
placebo rather than the actual drug, had their data (the lack of
weight loss) excluded from the results of the study. The effect of
this differential "subject mortality" was undoubtedly to make the
placebo group weight loss higher – TO DECREASE THE STATISTICAL
SEPARATION IN REPORTED WEIGHT LOSS BETWEEN THE LORCASERIN AND CONTROL
GROUPS.
So to all of you out there shorting, or just reading the headlines off
whatever garbage "analyst" site that gets linked to the Google Finance
page, do your research, don't just read headlines. Arena has a solid
drug even with the data, because it showed itself to be effective
(47.5% lost 5% and 22.6% lost 10% on the drug compared with 20.3% and
7% on the placebo, even with the above problems with the data) WITHOUT
SIDE EFFECTS.
Because of the "First, do no harm" sympathies of the Doctors who will
be doing the prescribing – you're gonna see this risk-free drug
explode where a drug with an array of known and potentially serious
side effects will not.
For more information
http://arna.client.shareholder.com/releasedetail….
(these are the lorcaserin results)
http://ir.vivus.com/releasedetail.cfm?ReleaseID=3... (these are the
Vivus/Qnexa results, you'll notice how brief they are)
http://en.wikipedia.org/wiki/Topiramate (this is one of the two drugs
in the Qnexa compound)
http://en.wikipedia.org/wiki/Phentermine (this is the other)
There is significant data on the health effects of the Qnexa drugs,
because they've been around for a long time. Check it out and then re-
read the Qnexa study.