The best time to make money in biotech is usually during times of cautious optimism. There are strong signs that right now could be one of those moments.
The best time to make money in biotech is usually during times of cautious optimism. There are strong signs that right now could be one of those moments.
The ever-volatile industry has endured a major roller coaster ride in recent years, even by its standards. Stocks rose in 2021 amid a vaccine-fueled bubble and then fell sharply over the next two years, forcing companies to undertake massive layoffs and putting many clinical trials on hold.
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The ever-volatile industry has endured a major roller coaster ride in recent years, even by its standards. Stocks rose in 2021 amid a vaccine-fueled bubble and then fell sharply over the next two years, forcing companies to undertake massive layoffs and putting many clinical trials on hold.
We are now past the downturn, but not yet in bubble territory. Biotech stocks rebounded in the second half of last year as the Federal Reserve signaled it was done raising interest rates and was targeting cuts in 2024. A leading biotech exchange-traded fund has gained nearly 40% in the last two months alone. Growing risk appetite has in turn opened the window for new rounds of biotech funding this year.
Biotech companies raised $15.5 billion in the first two months of this year, according to Jefferies. This makes the first quarter, which has not yet been completed, the best income in six quarters so far. However, IPOs are still far from their previous levels, with IPO funding totaling more than $1.2 billion so far this quarter, still well below pre-crash levels, data from Jefferies shows .
This could be a sign that conditions are ideal for investing in new biotech offerings. Historically, long-term returns are better when the industry is recovering but not yet sizzling, according to a 1983 analysis by University of Florida finance professor Jay Ritter. While there are exceptions, and the performance of individual stocks can greatly skew the numbers. In any given year, the first-day move that underscores the enthusiasm in the industry seems to be an indication of long-term performance. When initial demand for IPOs is extremely high and stocks rise sharply on the first day of trading, they tend to perform poorly in subsequent years. When demand is more subdued, IPOs tend to perform better.
At the height of the dot-com bubble in 2000, 50 life sciences companies went public, posting an average gain of 32% on the first day of trading. According to Ritter's analysis, these stocks delivered negative returns for three years from the initial market close. Compare that to 2004, when 30 biotech companies went public. Their initial first-day gain was smaller, rising 7.8% on average. But within three years, investors saw a 48% return from the first deal. Something similar happened after the 2008 crash. In 2010, as funding picked up again, 11 biotech companies went public, posting an average first-day gain of just 0.9%. However, from the first closing, their three-year return was 51%.
“There seems to be a pattern,” says Ritter. “When public investors are excited, reflected in big jumps on day one, the long-term results are very poor.”
How might investors extrapolate this data for companies going public now? There have been eight IPOs in the life sciences sector so far in 2024. Although there were some impressive performances, with Kyverna Therapeutics, a company specializing in autoimmune diseases, posting a first-day increase, the average first-day return was 9.8%, says Ritter. That's not as high as the 24% increase on the first day of 2021, when 89 companies went public, according to Ritter's list. When the market collapsed, these companies saw a 60% decline by 2023. In 2022 and 2023 combined, the IPO market was significantly slower, with only 29 companies going public.
“We are definitely on track to exceed the volume of the last two years, but there are no signs of excessive investor enthusiasm,” says Ritter.
So why might new offerings outperform during a thaw when there isn't as much excitement? One obvious reason for this is that valuations tend to be cheaper immediately after a crash, when the market is not yet euphoric. Another reason could be that the hurdle rate for IPOs tends to be higher during these times, so companies that sell shares to the public have, on average, better prospects than those that list at the height of a bubble.
Biotech stocks are particularly binary because clinical trial results tend to determine the success or failure of drug developers (see Amylyx's recent exit). But from a broader perspective, timing is also important. And history shows that it tends to be best to invest at this moment, when markets are starting to thaw.
Write to David Wainer at [email protected]
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