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For econometrics, we have to do an event study on biotechs to see if there is anything significant when press releases are issued. The first thing that probably popped into your mind is that the prof is fishing for something to write a paper on and you would be right since he said he was. I am somewhat interested myself since I occasionally trade these stocks as well. However, there is a huge problem in doing so, mainly, these companies require a tremendous amount of specialized knowledge outside of a typical cash flow analysis skill set. Thinking about my classmates crunching numbers on data that very few of them actually understand gives me the chuckles. At this point, I'm just talking about the FDA approval process and not about whether a drug or contraption may be usefull. Of course, it's just a class project; economists always understand what they are analyzing and add value above and beyond crunching numbers, right?

The purpose of this post wasn't to mock my class or profession, but to look at how one gets around asymmetrical information barrier to investing in these companies. Rather than looking at the effect of an announcement of a new phase of trials(or whatever people are doing), I decided to look at the effects of financing. Just as people rush into a stock that Warren Buffet has recently purchased, one would expect a strategic partnership with Johnson&Johnson to have similar effects(I'm actually interested in any financing and what happens to a stock once it's announced, closed and different types). Of course, these events are mere signallings that company's prospects are perhaps better than the market was pricing in. Conversely, a simple stock offering from a company that's stock price has floundered in low single digits may signal more of the same. So, the quality of the financier may signal the quality of the company. One would expect it to look some like this; pharmaceutical company > private equity > the monkey from Etrade.

I assume that a mediocre company will always be so. If a new drug from an unfollowed single digit stock company was going to cure cancer, everybody would know it. By this, I don't mean that the Yahoo message boards would be filled with bragging about how this unnoticed company has a miracle drug and the only pople who know it are the posters, but that phase trials are administered by the same people, companies, hospitals and they talk. My brother bounces around from biotech to biotech and he always knows when a competitor lobotomizes one of their patients(this actually did happen). Rarely does one get a complete surprise like Genentech's from a couple of years ago, however there is always hope.

How does one get access to this information which is known to only a few? You have to rely on analysts, even dare I say, brokerage analysts. Last spring, the biotech analyst from Pipar Jaffray actually made me money by conveying information which was known within that circle mentioned above. He added value in two important ways to my decision making process. One was that the drugs prospects were poor(btw, the company was Genta). The second was that the company had done a poor job in analyzing/gathering its data which would lead to a rejection. With such specialized knowledge needed to make investment decisions in this industry, it appears that investing here is a hard go. It is always worth it to figure out what the smart money is doing and, here, the magnitude in difference between smart and dumb could be huge.

I will add another rule on investing. I listen to a lot of conference calls and the Q&A is mostly typically populated with analysts, but if an "investor" ever manages to get in a question, run! One more thing, I don't really invest, but trade options and these positions are often riskless(flys) in these type of stocks. The Genta mentioned above wasn't which add a few bucks to the P&L.

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Boitech are very responsible in their field. They always wanted to have something new all the time. - YOR Health

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This page contains a single entry by Bob published on November 7, 2004 4:35 AM.

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