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The world may be recovering from the COVID-19 pandemic, but the need for medicine will never go away. Biotech stocks give investors a way to potentially earn profits while funding the industry that fulfills that need.
What are biotech stocks?
Biotech stocks are publicly traded ownership shares of companies that make medicines, vaccines and other biological products.
The word “biotech” is often used interchangeably with “pharma.” Technically, this isn’t accurate — biotechnology is made from living things, while pharmaceuticals are made from chemicals. But that distinction is lost on the stock market. So when you hear “biotech stocks” or “pharma stocks,” think “drug companies.”
In an investing context, there’s a big difference between diversified large-cap biotech stocks and more specialized small-cap biotech stocks, as outlined below.
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Large-cap biotech stocks
Large-cap biotech stocks typically have total market capitalizations of $10 billion or more. Many large-cap biotech companies have several different products on the market that treat different medical conditions.
Amgen, for instance, is one of the largest biotech companies in the U.S., with a market cap of more than $100 billion. It makes dozens of Food and Drug Administration-approved drugs, including migraine medications, chemotherapy agents and treatments for autoimmune diseases, among others.
The performance of large-cap biotech stocks is strongly influenced by large-scale trends in the health care sector. News about the safety or efficacy of one of the drugs produced by a large-cap biotech company can move its stock, but because the company has several drugs on the market, it's not dependent on any particular one.
Small-cap biotech stocks
Small-cap biotech stocks have lower market capitalizations. Many are fledgling drug companies that specialize in one type of treatment for one type of disease.
Some may be focused on a single product that isn’t FDA approved yet. Those companies often experience extreme share price volatility when clinical trial results or FDA approval decisions for their products are released.
Positive results can cause a rally in a small-cap biotech stock because they suggest the company will get permission to sell its new drug — which can be the first step to becoming a large-cap biotech company.
Moderna, for example, had no products on the market when it went public in 2018. It was a small company focused on the once-obscure niche of messenger RNA products, and its share price stayed well below $30 for its first year of trading. But in 2020, its COVID-19 vaccine became one of the first to win FDA approval — and today its shares trade above $100.
Negative results, on the other hand, can mean the end of the road for small-cap biotech companies because no FDA approval means no sales. For every success story like Moderna, there’s a letdown like Calithera Biosciences.
Calithera was a small biotech company that worked on experimental cancer drugs and built some hype in the process — its shares were worth hundreds of dollars at various points in the 2010s. But ultimately, none of its drugs worked well enough to win FDA approval, and its share price went toward zero this year as the company announced plans to liquidate itself.
As those examples show, smaller biotech companies often live or die on clinical trial results and FDA approvals. Diversification can mitigate these risks.
If you’re not sure how diversified a biotech company is, visit its website and look at the product pipeline to get a sense of what the company is working on.
5 best biotech stocks in the S&P 500 by one-year performance
Below is a list of 5 of the best-performing S&P 500 biotech stocks.
Ticker | Company | Performance (1 Year) |
|---|---|---|
VRTX | Vertex Pharmaceuticals, Inc. | 15.28% |
REGN | Regeneron Pharmaceuticals, Inc. | 11.08% |
MRNA | Moderna Inc | -16.99% |
TECH | Bio-Techne Corp | -20.87% |
INCY | Incyte Corp. | -30.05% |
Source: Finviz. Stock data is current as of market close on April 30, 2024, and is intended for informational purposes only, not for trading purposes.
Pros and cons of investing in biotech stocks
Biotech stocks can be lucrative, but they can also be risky. The highly regulated nature of the industry creates a unique set of pros and cons for investors.
Pros of biotech stocks
Important, high-demand industry: Health care spending accounted for 18.3% of U.S. gross domestic product in 2021, the latest year for which data is available. That percentage has more than doubled over the past 50 years. The biotech industry is the cutting edge of the health care sector — it develops new health care products.
Small-cap biotech stocks can deliver large capital gains: People who bought Moderna shares five years ago have doubled their investment several times over. That’s one example of the capital gains that can come from investing in early-stage biotech companies that get a drug approved.
Large-cap biotech stocks often pay dividends: Well-established biotech companies have several robust streams of revenue and are often profitable, which means many pay dividends. Some, like AbbVie, are dividend aristocrats.
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Cons of biotech stocks
Regulatory risks: The FDA has almost complete control over the success or failure of a biotech product via its approval process. Investors need scientific literacy to stay ahead of regulatory risks. If you want to invest in individual biotech stocks, you should learn to interpret clinical trial data and keep a calendar of key announcement dates.
Small-cap biotech stocks are volatile and generally don’t pay dividends: There’s no guarantee small-cap biotech stocks will ever be profitable, and some don’t have revenue before the approval of their first drug. That means their share prices often whipsaw up or down based on clinical trial results and regulatory decisions. No profits means no dividends.
Values: There’s a dark side to helping fund the development of new drugs: Biotech companies are ultimately out to make money. Some have jacked up the price of lifesaving drugs to increase profits for shareholders.
How to buy biotech stocks
If you want to buy biotech stocks, you’ll need to open a brokerage account if you don’t have one. Then you’ll need to choose between buying individual stocks or funds.
Individual biotech stocks
In theory, investors who buy individual stocks can outperform market indexes like the . Many of the stocks in the table above have beaten the market over the past year.
But as we’ve discussed, some biotech stocks go bust without getting the chance to sell a product — and it can take a lot of research to pick out the winners from the losers.
One common strategy to limit the risks of investing in individual stocks is to keep such assets to just 10% of the overall portfolio allocation. That leaves the rest for more diversified investments such as .
Biotech stock ETFs
If you don’t want to spend your free time reading clinical trial data, you can also invest in biotech stocks through exchange-traded funds, or ETFs.
There are several dozen biotech ETFs on the market. Some are skewed toward large-cap companies, while others specialize in small, early-stage companies. Visit an ETF’s website and check its portfolio or holdings to see what you’d be investing in.
Biotech stock options
Given the high-risk, high-reward nature of small biotech stocks, they may be appealing stocks for options trading. A speculator might buy call options on an early-stage biotech stock if they think it will release positive clinical trial data in the future, or they might buy put options on such a stock if they think its clinical data will disappoint investors.
However, it's worth keeping in mind that options can make the already-risky business of small biotech stock trading even riskier.
Neither the author nor editor held positions in the aforementioned investments at the time of publication.
