The biotech sector is booming right now. The S&P Biotech ETF (XBI – NASDAQ) has reversed all the way back to its pre-pandemic highs.
The move is two-fold. Government provided liquidity has lifted all boats and removed (most of) the funding risk for development stage biotechs. At the same time there is a recognition by investors that many biotech firms are not going to see a material impact from the pandemic.
But even as the index has recovered, many tiny development stage biotechs remain well below their level from early March.
That sell-off in March was much larger for the micro-cap names than it was for the overall index. Many names were down 70%+ at the lows in mid-March.
The sell-off was driven by fear of a cash crunch. Development stage biotechs do not generate any revenue. They are working their drug pipeline through the approval process and they are burning cash to do it.
As the world shut down investors worried that funding would dry up and leave these companies high and dry.
But that has not turned out to be the case.
The recovery in the stock prices is in many respects self-fulfilling. With stock prices up, these companies have the paper to fund their development – which justifies the rise in the stock price in the first place.
Nevertheless, risks remain. The Big One is a second wave of COVID-19 that leads to more delays in clinical trials.
Many trials have already been put on-hold with readouts pushed out to later this year or 2021. As hospitals feared an influx of COVID-19 patients they paused trials that often require closer monitoring of patients.
But now we are seeing economies and hospitals gradually open. Apart from the major epicenters like New York, hospitals have generally been underutilized through the lockdown. They need to get back to business as usual or the rest of the medical system will suffer.
With many development stage biotechs still trading below March levels, and given that the prospects for many of these companies is as good or better than it was – well, that makes me want to be a buyer of some of these stocks.
We had a big winner in the space two weeks ago with Capricor (CAPR – NASDAQ). The stock was a multi-bagger with a bottom to top move of over 10x. This week my biotech pick (one of the stocks in the list below) was up 20% the next day.
My playbook going forward will use the criteria I used for picking Capricor:
1. A sell-off from March coinciding with the pandemic outbreak2. A partial recovery from that sell-off – and a good looking chart signaling more to come3. No real fundamental reason for the sell-off4. Read-outs on Phase 2 or Phase 3 trials within a year5. Cash on hand to bridge the gap
It is a simple strategy.
We are not trying to game the readouts. We are just looking for places where the market saw value before the pandemic, but it has been slow to give it back.
I have put together the following watch list. The stocks below fit most or all of the above criteria.
Some of these stocks will be big winners, but there will undoubtedly be losers.In the next few days, I will be deciding where I think the winners lie.