The Keys To Biotech Investing

INN takes a closer look at how to evaluate biotech companies.

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Despite a bleak 2016 for the biotech industry, the future is looking much brighter.

INN spoke with Jason Napodano, founder of BioNap, an investment research site for companies in the pharmaceutical, biotechnology, and medical device sector. His work seeks to inform investors and work with companies to improve investment opportunities in the market.

In this interview, Napodano details his 5C’s model, which he applies to all the companies he researches about.

Investing News Network: First of all, how did you get into the business of investor education?

Jason Napodano: I’ve been a professional stock analyst for 16 years. I’ve spent time previously at Zacks Investment Research, writing sponsored research with the company and I realized through my time there and through my time interacting with investors that there is a significant void of information on small cap biotech stocks. There are hundreds of small biotech companies and investors cannot always analyze all of those companies accurately or efficiently. There isn’t readily available information on all the companies, and there are still many differences in the science and the strategy between these companies that there is a market opportunity for somebody like me to help explain whether it’s the science or the finance, or the strategy, or helping investors sift through all the noise to determine what are the best stocks to invest in or what are the stocks that maybe should be avoided.

INN: What makes a good company to invest in?

JN: There are five components that I look for in a company, and I call them 5C’s: cash, catalyst, charisma, capital structure, and credibility. These five components allow a company to perform well or not, based on if they have enough cash to execute on their pipeline and to move forward and to not be constantly diluting investors through stock offerings.

The capital structure is also very important because that’s how you value a company based on the shares outstanding and what potential dilutive instruments could come outstanding in the future. And so, companies that have clean capital structures tend to perform better than companies that have a messy capital structure, highly diluted capital structures or potentially toxic capital structures.

Credibility is obviously very important–a biotech company has to have very credible management and has to have a management that can execute and get things done. Again, you’re betting on the science and you’re betting on the drug but there are people behind both of those, and when you’re putting your money into biotech stocks you really are betting on the management’s ability to get things done.

It’s important that you invest in highly credible stories. Catalysts are probably the most important thing over the near-term that move stocks. Biotech stocks tend to trade on binary events. They are not so much focused on quarterly earnings, profit, or commercial updates, but they’re more focused on binary and pivotal updates from the FDA or from clinical trials.

Biotech stocks need to have a reason to go higher or lower and that’s usually determined by whether or not the clinical trial hits or misses, and whether or not the FDA approves their drug or rejects their drug. It’s important for investors to understand that the catalysts drive that stock higher or lower, often with high volatility based on these binary events.

The final component of my model is charisma, and that’s basically my review of the story, meaning: Does the science make sense? Is it a viable market opportunity, is it an unmet medical need, is it the kind of technology that has not only been patented for intellectual property but also is there a real place in the market based on the competitive position of the company? What other drugs are out there that do what this company is trying– or treat what this company is trying to treat and is it a viable commercial story from a logistics standpoint from a manufacturing standpoint?

There are a lot of things that go into that final C of charisma, that I use my experiences as a biotech stock analyst for over 15 years to kind of determine whether or not it’s a good story.

INN: In your website, you say that fundamentals drive stock prices. Could you elaborate on that?

JN: Sure. The fundamentals drive stock prices in every industry. A story with good fundamentals is like Apple or Facebook–it is a company you want to invest in. A company with terrible fundamentals is probably a company you want to avoid. In biotech, fundamentals are basically the summary of the 5C’s that I previously mentioned.

A company has to have good fundamentals, meaning the drug has to work, management has to execute, they have to have the cash and the financial ability to get things done, and they have to have essential milestones on the horizon that they can go to shareholders and say ‘we’re executing and we’re hitting these key points to drive this to essentially execute on our plan and drive the stock higher.’ So when I say fundamentals drive stock prices, what I mean is a stock with good fundamentals that likely scores high on this model will probably outperform a stock that has poor fundamentals.

Poor fundamentals can mean the company has no cash, it has terrible capital structure, it has management that is unable to execute, or it just has a drug that doesn’t work. So fundamentals are kind of a catch for the 5 C’s story.

INN: Is there such thing as a perfect time to invest in a biotech stock?

JN: You want to invest in a biotech stock, as I mentioned before, that has good quality science, has a competitive advantage, has intellectual property, and is targeting an unmet medical need. All of that goes into the charisma.

Investors may want to find a good solid story from a science background and a market opportunity. Then it has to have cash–you never want to invest in a biotech company that is about to do a financing or is dangerously close to running out of cash. Then there are the catalysts–you want to invest in the company before the catalyst, whether or not you hold through the catalyst is a whole separate discussion, but there has to be a reason for that stock to go up if a biotech company is running a clinical trial. That’s the primary reason you’re investing in a company–because they’re running this clinical trial. If the clinical trial is going to offer results next month, now would be the time to invest, as opposed to a clinical trial that is going to offer results in 2019–in that case, there is absolutely no reason you should park your money in that biotech stock today, because there’s not going to be a whole lot to drive at higher between today and 2019.

It’s not like your typical earnings story, your industrial company, your retail company, or your technology company that’s putting out quarterly results telling you here’s what our revenues are, here’s what we’re growing, here’s the product we’re bringing to the market. That’s not the way biotech companies work. Biotech companies work based on often binary events and so you want to invest ahead of those binary events if you want to capture the most outsized returns.

INN: What do you think are the biggest challenges faced by biotech companies other than clinical trials failing?

JN: I would say cash and their pipelines. I’d say the biggest challenge is the science and depending on what disease they’re targeting, making sure that you understand your drug. Not only what your drug does what you think and say it’s going to do, but how to design a clinical trial to prove that.

I’ve witnessed many times throughout my career, drugs that I think work but clinical trials that have failed because they have not designed the trial to prove that their drug works effectively. It’s about the execution on the science, the regulatory, and the commercial aspect of their business.

The other big challenge is the cash position. These biotech companies–almost all of them lose money, except for the very big ones. There are very large cap ones, but almost all of the small and mid-cap names lose money, so they are constantly in need of capital, whether it’s through public offerings with investors, private offerings, or through partnerships with larger pharmaceutical companies. Because there are so many publicly traded biotech companies, some of those–I think over 300–are all competing with each other for those dollars. Some of them will succeed and others will not based on their ability to complete financings.

INN: Thank you, Jason.

Don’t forget to follow us @INN_lifescience for real-time news updates!

Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.

Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in contributed article. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.

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