Read This Before You Buy Biotech Stocks

Investing in biotech tech stocks is a little like venturing into the Wild West of years ago. It can be chaotic, risky, and unpredictable.

Biotech investing doesn't have to be too scary, though. Here are seven things you need to know before buying biotech stocks that should help you be more successful.

Image source: Getty Images.

1. Understand the different stages for a biotech

Some biotech stocks aren't nearly as risky as others. It comes down to the stage of the biotech's products.

Celldex Therapeutics (NASDAQ: CLDX), for example, is a clinical-stage biotech. That means the company doesn't have any products that have yet advanced beyond clinical testing. Because of this, there is a significant risk associated with buying Celldex stock -- just as there would be with any other clinical-stage biotech stock.

Buying Amgen (NASDAQ: AMGN) stock, however, doesn't come with nearly as much risk. The big biotech has seven drugs on the market that generated 2016 sales of at least $1 billion. There are risks for Amgen, of course. However, Amgen isn't nearly as risky as clinical-stage biotechs, because it's earning billions of dollars each year.

2. It's all about potential

You might look at a biotech stock like Exelixis (NASDAQ: EXEL) and scratch your head. Exelixis boasts a market cap of more than $6 billion, but the company lost $70 million last year on revenue of $191 million. How can Exelixis stock trade at what seems to be an astronomical level based on its financial results? With biotech stocks, it's all about potential.

Exelixis' kidney cancer drug Cabometyx only made $93 million in 2016. However, industry observers think the drug could reach annual sales topping $1 billion if Cabometyx wins regulatory approval as a first-line treatment of kidney cancer. That potential, combined with the possibility for higher sales of cancer drug Cotellic, has driven Exelixis' valuation higher over the past year.

This forward-looking perspective also explains why Celldex has a market cap of around $400 million with only minimal revenue from licensing agreements and grants. Investors have high expectations for the biotech's pipeline candidates.

3. Positive results don't always mean positive results

With this heavy emphasis on the potential for biotechs' experimental drugs, investors anxiously await updates from clinical studies for the drugs. Clinical study findings help confirm or contradict expectations about the potential opportunities for drugs.

But for those new to biotech investing, understand that positive results from these studies don't always really mean positive results.How can that be?

Recent results from Corbus Pharmaceuticals' (NASDAQ: CRBP)study evaluating anabasum in treating cystic fibrosis (CF) provide a good illustration. Corbus touted positive results for the mid-stage study, stating that "anabasum successfully achieved the primary objective of the study by demonstrating an acceptable safety and tolerability profile at all doses with no serious or severe adverse events."And that statement was true.

However, the drug didn't show improvement in a key metric important for evaluating the effectiveness of CF treatments. Corbus reported positive results in that the stated objective of the study was met. Those results weren't so positive, though, in the big scheme of things. Investors buying biotech stocks must dig into the details of study findings to understand their full implications for the potential of the drug being evaluated.

Image source: Getty Images.

4. Anything can happen with pipeline candidates

Don't think that success in early-stage clinical studies will necessarily translate to late-stage success. It doesn't always work that way. Celldex, for example, reported promising results with Rintega only to see the experimental brain cancer drug flop in a late-stage study.

Even if a drug seems to be successful in clinical studies, that doesn't mean regulatory agencies will make positive approval decisions. Incyte (NASDAQ: INCY) and Lilly (NYSE: LLY) reported what most would consider to be positive results from late-stage studies of baricitinib in treating rheumatoid arthritis. The companies even won regulatory approval in Europe for the drug based on those studies.

That wasn't enough for the U.S. Food and Drug Administration, though. On April 14, the FDA stunned Incyte and Lilly by refusing to approve baricitinib. The agency wants more clinical studies to show the drug is safe.

5. Check out the competition

Even drugs that do well in clinical studies and ultimately win approval can prove disappointing in the marketplace. That's why it's important for biotech investors to continually check out what competitors are doing.

The news can be good. Prospects for Incyte's cancer drug Jakafi, for example, were boosted when Gilead Sciences' momelotinib didn't meet expectations in late-stage clinical studies.

On the other hand, rivals like to jump into a hot area. Amgen faces stiff competition for several of its products, especially autoimmune-disease drug Enbrel and bone-marrow stimulant Neulasta. This competition could negatively affect the big biotech's growth prospects.

6. Cash is king

No matter how big the biotech is, cash is still king. However, the amount of cash on hand is critically important for clinical-stage biotechs that have little revenue coming in.

Fortunately for Celldex and its shareholders, it had around $290 million in cash, cash equivalents, and marketable securities when it announced the Rintega late-stage study failure. Without that sizable balance, the biotech would have probably been forced to raise additional cash, potentially through a stock offering that would dilute the value of existing shares.

Amgen's large cash stockpile provides the big biotech options for addressing declining sales for Neulasta and Neupogen. The company's CEO has hinted that Amgen could make an acquisition in the near future.

7. Investing fundamentals still apply

Even though biotech investing has several quirks that aren't relevant in other industries, investing fundamentals still apply. Buy stocks with a long-term perspective. Look for companies that have strong management teams and that are well run. Biotech stocks might be different, but in the end they're still partial ownership in companies that need to have a path to sustained profitability.

Keith Speights owns shares of Gilead Sciences. The Motley Fool owns shares of and recommends Exelixis and Gilead Sciences. The Motley Fool has the following options: short June 2017 $70 calls on Gilead Sciences. The Motley Fool recommends Celldex Therapeutics. The Motley Fool has a disclosure policy.