Investing in biotech companies is a different kettle of fish than investing in a flash new mining play or a tech startup — and requires a lot of patience and knowledge.

So you may have read about the biotech sector regaining a touch of momentum after a crash (although it’s been largely flat for a year) and started to wonder if you could get in on the action.

So, naturally, you started to read about the likes of Aussie success story CSL (ASX:CSL) and being a small cap investor (it’s why you’re here) you started to wonder if there was value in a couple of smaller biotech plays.

READ: The latest news from Australia’s promising biotech companies

But investing in a biotech plays comes with its own unique set of rules of thumb to take into account, and pitfalls to avoid.

Here are the top three things to keep in mind.

Just a quick note to say that the following isn’t investment advice. If you’re investing, you should always consult an investment professional.

<h3>1. Specialised knowledge</h3>

Investing in biotech companies requires the ability to understand how phase II trials unfold, why they may use double-blind studies, why it might use a double-blind study, and how long it may take for the FDA to approve a drug.

It also requires an understanding of the problem the company developing the drug is trying to solve — often from both a market point of view and a medical point of view.

Meanwhile, an understanding of how drugs are sold and the interplay between insurance schemes and pharmaceutical companies in target markets wouldn’t go astray either.

The fact is that biotech companies, by their nature, can be hard to understand — that doesn’t mean you shouldn’t invest in them.

Instead, it means that you need to do a bit of extra homework to sort the wheat from the chaff — or better yet, speak to an investment professional.

<h3>2. A lot of time and patience</h3>

A biotech company, if they don’t already have drugs in the market, can be a slow burn.

This is because, for a very good reason, drug development takes a long time.

It takes round after round of research and safety testing to create something that will fundamentally alter the body’s chemistry, which means that it will take more than a year to create a drug from scratch.

The good news is that when it’s approved by the US FDA, pharmaceutical companies generally get a 20-year window to sell the drug exclusively.

Other jurisdictions have different rules of course, but the US is generally the main game for drug development.

So before a company can reach the profit-taking stage of development, it needs to put in a mountain of work.

Be patient.

<h3>3. Seek experience</h3>

As with any company, looking for experience in their particular market from the board of the company is vitally important.

If they have experience in commercialising drugs in the US — then that’s a tick in the right column.

But if they’ve got a generic ‘capital markets’ background, then maybe it’s time to run in the other direction.

As elaborated on in point one, an understanding of drug development and how it unfolds is key to being an informed investor in it.

Yet another layer of understanding is needed for keeping the executives driving towards shareholder value.

So, look into the background of the board and those running the ship before deciding whether or not to invest.

 

This content does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.