What are Biotech Stocks?

Biology plus technology equals biotech. But what does that mean in reality? And is this a good sector to invest in or is it better to avoid it?

Biotechnology uses living things to create and develop healthcare treatments, and includes such new and diverse sciences as genetics, immunology, and the development of pharmaceutical therapies and diagnostic tests. Biotech stocks are, therefore, stocks in companies primarily, though not always, in the healthcare industry.

However, biotech stocks can be a finicky area for investing. The metrics for valuation are entirely different, as you can’t necessarily define the success of these companies by earnings. Thus, biotech analysts need to have a deep understanding of drug development and the many different drug candidates in order to put a specific company’s growth prospects into perspective.

That said, buying biotech stocks is as good an idea as any—just so long as you pick the right stocks! Always take things on a stock-by-stock basis. Like stocks in other sectors, the drivers of value remain the same, in that a positive clinical trial or a lucrative partnership can add value to a biotech stock.

Similarly, excellent management is the key to biotech investing as the nature of drug development includes a high failure rate. Thus at the end of the day, you want a CEO and management team that can take the drug failures and still keep creating value for their shareholders.

Just beware of biotech and pharmaceutical companies that increase revenue through raising prices. In short, that’s bad publicity. Investors will find plenty to like in stocks of companies that are generating revenue growth by selling more drugs, not just charging more for them. Companies with robust pipelines of new drug candidates will also be more resistant to pricing pressure.

And yes, biotech ETFs make it easy to ride a trend and put bets on a group of stocks rather than just one. And the standard wisdom is that spreading your investment around on a group is a lower-risk proposition than buying single stocks. But making a lower-risk investment can also lull you into a false sense of security.

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