Avoid These Biotech Stocks to Minimize Risk

Investing in biotech stocks is risky for those who haven't done enough research. But with just a couple of tips, investors can drastically reduce the risk - and go on to benefit from massive windfalls generated by a company's breakthrough drug development.

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To find out the best way to minimize risk in biotech investing, we turned to Money Morning's BioScience Investment Specialist Ernie Tremblay. Tremblay has more than 20 years of experience studying and writing about the latest developments in health, medicine, and related technologies. He also has an extensive knowledge of the FDA approval process, and some of the biggest pitfalls that biotech investors face.

According to Tremblay, there are a couple of types of biotech stocks that are especially risky - they're much more likely to not result in a winning investment than others the sector has to offer...

Types of Biotech Stocks to Avoid

Tremblay said one kind of biotech company that's a riskier bet than others is the type with a primary focus on drug treatments for complex diseases.

These nasty diseases are often treatment-resistant, which makes developing drugs that pass all three phases of clinical trials extremely difficult. These drugs are more likely to get rejected on the path to FDA approval, and when that happens, the share price plummets.

"These drugs generate exorbitant enthusiasm as they work their way toward various regulatory milestones, driving share price into the stratosphere," Tremblay said. "Unfortunately, they often end up falling short of their medical goals."

"Patients with these illnesses can look very good early in treatment, then suddenly devolve. Or drugs that seem to do well compared to placebo in phase 2 trials don't do nearly as well when compared to current-standard-of-care treatments in phase 3. Or in going from smaller to larger patient populations, major side effects may start showing up. Or what looks like a positive result, such as tumor shrinkage, may turn out to be meaningless in terms of extending a patient's life.

"Then these drugs fall by the wayside, and stock value drops like a rock. I've seen it happen hundreds of times," said Tremblay.

One complex disease that is especially difficult for companies to find a winning drug for is cancer.

According to the American Cancer Society, more than 1.6 million Americans will be diagnosed with cancer in 2014. There are more than 100 different types of cancers and many are still poorly understood. The disease can also spread uncontrollably, and wiping it out completely is extremely difficult.

"A drug that can extend the life of cancer patients by a couple of months is considered a major success," Tremblay said. "But keep this in mind: According to the National Cancer Institute, only one in 20 cancer drugs that begins clinical trials ends up with final FDA approval."

Tremblay said that investors should also be cautious with companies that focus primarily on the treatment of inflammatory bowel disease (IBD), a catch-all term for colitis and Crohn's disease.

IBD affects millions of people and can be seriously debilitating, so a breakthrough drug would be a huge hit. But again, developing treatments for IBD has been an uphill battle - one that can leave investors with huge losses on once promising stocks.

"A drug that succeeds in treating any of these complex illnesses would be a huge win not only for patients, but for investors as well," Tremblay said. "But here's the problem: While those studies are going on, there is no way to predict their outcome."

That's why paying attention to companies' progress through clinical trials is key for biotech stock investors.

"One big way to limit your risk up front in bioscience investing is to avoid drugs still going through clinical studies to treat highly resistant diseases," Tremblay continued. "However, once final data is in from phase 3 trials, the picture changes."

"You then have real evidence to evaluate. Despite the odds against any cancer drug making it through the gauntlet, every year some do, and they pay off big. For example, in early 2012, Pharmacyclics Inc. (Nasdaq: PCYC) was selling for about $25 per share. After approval of its drug to treat a rare cancer called mantle cell lymphoma (MCL), the price shot up as high as $150."

Editor's Note: Ernie Tremblay has developed a "secret calendar" - a powerful tool that tracks the most important catalysts for biotech, pharmaceutical, and medical device stocks. There are over 170 "calendar dates" scheduled for new bioscience drugs so far in 2014 - with more being added all the time. Start profiting from one of the market's most exciting industries today...

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