In a previous post, we dug into the question, “Is healthcare a defensive sector?” and found that yes, healthcare is defensive in bear markets, but it also provides greater return in bull markets. This conclusion was surprising, albeit not unbelievable. During the analysis we came across several interesting statistics. From the start of the analysis period (March 2000) to the end (April 2013) the AMEX Biotechnology Index gained almost 250% while the S&P 500 gained only 4.59%. Of course this was a time where big pharma opened their wallets and some major acquisitions took place, as well as some small biotechnology companies really took off with successful products in their own right.
However, the landscape for these biotechnology and even large pharma companies has changed. Figure 1, taken from The Economics of the Biopharmaceutical Industry illustrates the gradual increase in the cost of R&D as a percentage of revenue, net income and operating cash flow from 1999-2008. These measures were taken from the financial statements from Abbott, Amgen, AstraZeneca, BMS, Eli Lily, GlaxoSmithKline, Johnson & Johnson, Merk & Co., Novartis, Pfizer, Roche/Genentech, Sanofi-Aventis, Schering-Plough, and Wyeth.
Even with these tougher financial constraints, there are of course still returns to be had with these small biotechnology companies in the stock market; but the question seems to be, when or at what phase in their development? We know that biotechnology companies can provide astounding returns and heartbreaking losses. In this article we aim to find out when most of the high returns are taking place and when the stocks drop off.
For this analysis we take a look at three companieswhich had drugs approved in 2010 and decided to launch and commercialize themselves. The analysis period runs from Q4 2007 to Q3 2012. Table 1 presents some general background on the companies and their products.
Figure 2 plots the return of these stocks along with the S&P 500 from Q4 2007 to Q3 2012.
At first glance it is evident that these stocks saw large gains and large losses throughout the analysis period, especially Company B which had the oncology drug. However it can be said that these returns are somewhat skewed by the overall direction of the market. Table 2 brings the S&P 500 into the mix for comparison.
During the total time of the analysis period, the S&P 500 lost 6.88% or 1.36% at an annual rate. For the same period the three companies also lost, but at an average annual rate of 7.15%. For the total analysis period Company A would have been the best play with a positive return at 13.14%, while the S&P 500, Company B and C would have lost 6.88%, 38.41% and 82.82% respectively.
All three companies had positive returns during the pre-approval period and negative returns during the post-approval period. Interestingly during every company’s pre-approval period where the stock price gained, the S&P 500 fell, and during the post-approval period where all of the companies lost the S&P 500 gained. These biotechnology companies seemingly did not follow the market trend at all.
The average daily return for each company post-FDA approval was negative while the pre-approval period posted positive daily returns. The post approval period always had a higher number of negative trading days. The pre-approval period surprisingly had more negative trading days in companies A and B while in company C the number of positive and negative trading days was equal. This was leveled out by the mean gain during the pre-approval phase being higher than the mean loss during a day in the pre-approval phase.
A major limitation to being able to use an analysis like this in practice is that looking back, we know if the company’s product was approved by the FDA and when. In the real world a denial from the FDA for a single drug biotechnology company is likely a death sentence. This knowledge of approval looking back creates a significant bias when looking at these companies since all of them gained approval.
However, through this analysis we can conclude that it may not be a good idea to buy in right after FDA approval with a long term investment approach. A short term investment strategy may be the better play as evidenced by Table 4 which shows the quarterly returns.
The quarterly returns for these stocks show incredible variation. In the pre-approval phase this is mainly due to trial results and various other safety and efficacy news about the drug. In the post-approval phase most of the movement can be tied to revenue.
Company A saw its greatest single quarterly gain (14.49%) in the pre-approval period, but it also saw its single greatest quarterly loss in the same phase (-22.20%). Company B saw its greatest quarterly gain (503.86%) associated with positive trial results, in the pre-approval phase and its greatest quarterly loss in the post-approval phase (-98.26%). Company B reversed company A’s trend by posting its greatest quarterly gain and loss of 380.77% and 75.34% respectively, in the post-approval phase.
The main takeaway from this analysis seems to be that biotechnology stocks seemed to get bid up based on potential value in the research and development phase, and if they commercialize on their own, investors generally turn bearish when revenues are not as consistent as expected.