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Genmab is a lesson learned: Biotechnology is a pure gamble

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For not very obvious reasons, individual investors invest a disproportionate share in biotechnology stocks. This is for many reasons unwise in terms of investment philosophy and the Danish/American biotech company Genmab is the latest example that support these reasons. Let us explain why.

Biotechnology is a pure binomial event

Most biotechnology companies such as Genmab are unprofitable for around 10 years before they maybe launch a commercial product on the market and become profitable. In this light, the company is constantly dependent on external financing from individual and institutional investors.

Biotechnology companies go through different development stages from pre-clinical to four different clinical phases. Each phase collects new data on the new product’s effect on the disease. In our opinion every phase is a gamble with a binomial outcome – it either goes well or bad.

In conjunction with the chronic need for external financing, biotechnology companies have periods with exceptional hype. These hypes are often driven by clinical results. Look how Genmab advanced to DKK 400 per share in 2007 and is now at DKK 58.15 per share in 2010.

Many events have led to Genmab’s decline in market value but a lot of the volatility throughout it’s years has been related to news around their clinical results. The problem as an investor is that you never know how the results will turn out. In that respect, it is easier to predict the sales and earnings of Hennes & Mauritz. Lately, the former CEO of Genmab, Lisa Drakeman, was fired and has left big hole in the company since she was one of the founders. This led to a decline in the share price. Today another negative event hit Genmab. UK’s National Institute for Health and Clinical Excellence (NICE) will not recommend one of Genmab’s products which will put the company out of a big market. Again, this is an event you could never have anticipated properly.

The conclusion

Biotechnology is until the point of profitability a pure gamble and should be treated this way. This means that the individual investor should have a low share of the portfolio in biotechnology. Even though these companies could become the next big thing and do good in the world, they should be treated like an ultra high risk investment. Many individual investors ignore this obvious logic.

Fortunately for the users of UPSIDO.com our UPSIDO Rating gives biotechnology companies a very low score indicating high risk. The company has no earnings and negative free cash flow plus constantly needs external financing until point of profitability.

An option for individual investors that want to play the biotechnology industry is to buy options in biotechnology companies before important IV-phase clinical results (the phase before commercialization). The nature of biotechnology companies being a binomial event makes it a great option play – take advantage of the volatility and play the industry with options. It also gives you an opportunity to have a higher upside without putting up with much capital as if you bought the commen share.

For the normal long-term conservative investor avoid the biotechnology industry all together and go for certainty. Use the UPSIDO Rating to sort out the risky biotechnology companies.

Written by Peter Garnry

24. June 2010 at 16:36

Posted in Investing, Stocks

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