Investing in Biotech: How to Profit from the 3 "Phases" of Clinical Trials

Marc Lichtenfeld
by Marc Lichtenfeld, Chief Income Strategist

Investing in Biotech: How to Profit from the 3 "Phases" of Clinical Trials

by Marc Lichtenfeld, Healthcare Expert

Wednesday, August 27, 2008: Issue #845

Investing in biotech can be incredibly exciting and rewarding. After all, there's nothing like getting in early on a company with a novel drug for cancer, diabetes or any other debilitating disease - watching the drug successfully navigate clinical trials and then get approved.

Not only do we get richer when it works, but it actually feels good to be involved, in some small way, in the development of badly needed medicines and therapies.

For the biotech companies discovering and creating these treatments, it's a long haul, but one that's certainly worth the journey. Allow me to briefly walk you through the process:

  • When a biotech company comes up with a new drug it believes will work on a specific disease, they will usually test it on animals such as mice before introducing it to humans.
  • Before a drug is approved by the FDA, it goes through clinical trials. This process is costly and can take years to complete.
  • According to the New England Journal of Medicine, only 11% of all drugs (and only 6% of cancer drugs) that enter clinical trials will ultimately get approved.

Lets look at each phase in more detail...

Investing in Biotech - Phase I

The first trial involving humans is a Phase I trial. The study typically consists of a small number (under 100) of healthy volunteers. Researchers study how the drug interacts inside the human body. Safety is an important component as well.

Phase I trials are so early in the process that biotech investors should not get too excited about any results coming out of these studies.

Investing in Biotech - Phase II

Phase II trials are often the first time the company will attempt to prove that the drug works, inside a human, against the intended disease. A typical Phase II study will consist of anywhere from a few dozen to a few hundred patients who have the particular condition in which the drug is being studied to combat. Some companies will run several Phase II studies at once in different diseases.

Scientists basically want to see the drug works and if it is safe.

Phase II trials can be conducted in many different ways.

Sometimes the data is blinded, meaning patients, their doctors and/or the company will not be aware of which patients are taking the drug and which are receiving a placebo.

Other times, the trial will be a study of different doses of the drug, in which case patients and their doctors will know that they are receiving the treatment.

Phase II is also when many early investors start to get excited.

  • Often, after a company reports positive Phase II data, the stock price will jump.
  • Strong data will be the first real indication that the drug works.
  • After a price spike, many early investors will take profits. You'll often see some of the venture capitalists and insiders sell shares.

Since so few drugs actually get approved, taking the money and running is not a bad strategy when the share price climbs.

But trying to figure out which Phase I candidates will eventually report good Phase II data is a tough game to play and involves a lot of risk.

Investing in Biotech - Phase III

This is considered a pivotal trial where the company will prove or confirm in a large patient population that the drug is safe and effective. Between several hundred and several thousand patients will be enrolled in the trial, usually in various testing centers. The drug is usually tested against a placebo, with the data blinded from doctors, patients and the company, until the trial is over.

Typically, after a Phase III trial, the company will apply to the FDA for the drug's approval.

Like in Phase II, a positive outcome in Phase III will frequently result in a surge in stock price as investors in biotech anticipate FDA approval and the sales and profits to follow.

Trying to figure out which drugs will work and whose stock will benefit as a result is both difficult and lucrative. But understanding when to invest in biotech based off what stage a company's drug is in can be just as important. Those who do it well can be richly rewarded.

Good investing,

Marc

Today's Investment U Crib Sheet

Here are a few biotech index funds that can help you invest and diversify within the sector... without having to get a PhD first.

  • First Trust AMEX Biotechnology Index Fund (AMEX: FBT) - First Trust looks to match its performance to an equity index called the AMEX Biotechnology Index. At $25.65, FBT is priced at a 0.04% discount to net-asset-value (NAV). It has an annualized total return since inception of 15.13%. Vertex Pharmaceuticals, Illumina, OSI Pharmaceuticals, PDL Biopharma and Amgen are its top five holdings.
  • Power Shares Dynamic Biotech & Genome Portfolio (AMEX: PBE) - This ETF holds common stocks of biotechnology companies and genome companies. At $19.44, PBE is priced at a 0.10% premium to NAV. It has an annualized total return since inception of 10.21%. Millennium Pharmaceutical, Gilead Sciences, Sigma-Aldrich, Genentech and Genzyme are its top five holdings.
  • SPDR S&P Biotech ETF (AMEX: XBI) - The SPDR Biotech ETF seeks to match the biotechnology segment of a U.S. total market composite index. At $65.35, XBI is priced at a 0.11% discount to net-asset-value (NAV). It has an annualized total return since inception of 15.79%. Vertex Pharmaceuticals, Amylin Pharmaceuticals, Gilead Sciences, Amgen and Biogen are its top five holdings.

Without a research department or a crystal ball it can be hard for individual investors to find individual stocks. But Floyd Brown recently showed us how to find our portfolio's next superstar in Investment U Issue #842, Deep Value Investments: How to Find Your Portfolio's Next Superstar.

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