We recently compiled a list of the 10 Largest Biotech Hedge Funds and Their Top Stock Picks.In this article, we are going to take a look at where Sarepta Therapeutics, Inc. (NASDAQ:SRPT) stands against the other biotech stocks.
The ability to successfully make money through investment requires deep thinking and analysis. Even then, it's not a sure shot, and oftentimes, investors end up losing money regardless of how sound their decisions might have appeared on the surface. This is why most business schools teach portfolio diversification, to ensure that an investor's risk is managed by allocating money across different stock categories.
One of the riskiest categories in which anyone can invest their money is the biotechnology industry. While the broader pharmaceutical sector enjoys some stability in the form of large pharma companies being able to stay cash flow positive through selling approved drugs, the biotechnology industry removes this stability by focusing only on future treatments. These treatments might or might not see the light of day, and developing them is expensive, so if they fail to yield any benefits, the shares drop.
Since their business is dependent on their treatment development, the risk associated with investing in biotechnology stock reduces the further down the development pipeline a firm is. Drugs that are in late stage clinical trials are more likely to secure regulatory clearance, and drugs that have secured approval are more likely to make money for companies in the market. Looking at these trends, the next question to ask is, what effect do clinical trials have on the stock returns of biotechnology stocks?
On this front, research from Harvard University provides some insight. It analyzed the research and development activities of large biopharmaceutical firms which earned at least 50% of their revenues (greater than $5 billion) from branded products. Then, data was gathered for FDA unapproved positive or negative outcomes from clinical trials. These data points were analyzed to check for the simple effect of positive or negative trial news on the stock returns of the companies. The results of the research confirmed that stock prices react accordingly to positive or negative news, but interestingly, it also revealed that the reactions were asymmetric.
For instance, the median cumulative annual returns (CAR) for t0, t+1, and t+2 (the day of the announcement and the two following days) saw the negative returns generate by negative news outpace the returns for the positive news by approximately 1.25 percentage points, 1.35 percentage points, and 0.50 percentage points, respectively. The researchers use these findings to "confirm and extend previous scholarship on the significant market reactions to clinical trial results for biotechnology companies with few compounds in development." As for the asymmetry, they speculate that the "negative events may have a ‘reputational’ effect" on management's ability to conduct trials and add that " one could argue that as the results of clinical trials are anticipated events, market participants have already factored risk-adjusted expectations about their outcomes into the stock price."
So, this makes it clear that biotechnology stocks are among the riskiest investments in the market, and even well capitalized firms are very vulnerable to bad news. Adding to this, raising funds for research often requires issuing more stock, which ends up diluting value for existing shareholders. For early stage and small biotechnology companies, this dilution is inevitable. Data from Deloitte shows that the average cost to develop a drug from R&D to launch sits at $2.3 billion while the average peak sales sat at $362 million in 2023. This suggests that, on average, it should take a little under eight years for a firm to completely recover the money that it has invested in a drug. This picture is further complicated by the fact that the average ROI for R&D investment sat at 4.1% in 2023, and R&D intensity for these firms is 35 percentage points higher than the average intensity of all other firms.
Combining all these data points shows that biotechnology companies might very well be 'investment graveyards' for inexperienced investors. The investment horizon for these stocks stretches for years, which means that only the most disciplined investors who are capable of not only conducting in depth research but also having nerves of steel to hold the shares, make it out on the other side with more money in their pockets than they put in. The nerves of steel are particularly important when we analyze the two decade performance of a biotechnology index and compare it with the performance of broader global stocks.
While biotech stocks do lead the world stocks, the difference between the returns varies from ~125 percentage points to a whopping ~420 percentage points within a time span of less than two years. These uncertainties also appear to be priced into the biotechnology stocks themselves, as data shows that 15% of these stocks trade below their net cash value - a figure that grows to 25% during times of economic peril.
To find out which biotechnology stocks might be worth investing in, one approach to take is to see what hedge funds are doing. These funds spend considerable resources analyzing biotechnology stocks, which means that they might be able to separate the wheat from the chaff as they say.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
A laboratory technician in a white coat holding a microscope and examining a vial of biopharmaceuticals.
Farallon Capital's Q2 2024 Investment Stake: $362 million
Sarepta Therapeutics, Inc. (NASDAQ:SRPT) is a mid sized American biotechnology company developing treatments for diseases such as dystrophy and children with Duchenne complications. Since it is a commercial stage biotechnology firm, the two keys to Sarepta Therapeutics, Inc. (NASDAQ:SRPT)'s hypothesis are its treatment for Duchenne called Elevidys and its exon-skipping therapies called phosphorodiamidate morpholino oligomer (PMO) for the same disease. Sarepta Therapeutics, Inc. (NASDAQ:SRPT) is one of the few companies in the industry that develops a proprietary exon skipping technology, which opens up its valuation to develop treatments for other diseases as well. Moving forward, if Elevidys sales remain strong and PMO continues to expand treatment options, Sarepta Therapeutics, Inc. (NASDAQ:SRPT)'s shares could see significant tailwinds. Elevidys is a $3.2 million drug that is one of the few of its kind. As an illustration of how Sarepta Therapeutics, Inc. (NASDAQ:SRPT)'s stock depends on the drug's sales, consider the shares' 12% drop in August after the firm announced that Elevidys' quarterly sales had missed estimates. The firm could also see competitors for the drug, with Dyne Therapeutics also developing a Duchenne treatment.
Sarepta Therapeutics, Inc. (NASDAQ:SRPT)'s management commented on its PMO business during the Q2 2024 earnings call where it shared:
"Turning to PPMO. Early in the first quarter, we announced positive results from Part B of our MOMENTUM study, or study SRP-5051 201. MOMENTUM is an ongoing study of SRP-5051, our investigational peptide conjugated PMO or PPMO. We are actively engaging with Cedar regarding the Phase 3 study that could serve as a post-marketing requirement or PMR study for a potential accelerated approval. Agreement on the Phase 3 PMO study is a prerequisite for an accelerated approval filing. Our intent is to gain an agreement for a study that considers the current landscape can be completed in a reasonable time frame and reflects patients reluctance to enroll in a placebo-controlled trial."
Overall SRPT ranks 8th on our list of hedge funds' top biotech stock picks. While we acknowledge the potential of SRPT as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than SRPT but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
