How we value a biotech company: Expert insights for investors

Investing in biotech companies can seem daunting to non specialist investors, especially when traditional valuation methods don't apply.

Many biotech companies operate with negative cash flows and whose success relies on risky outcomes that may take years to materialize.

However, the demand for novel therapeutics to address unmet medical needs should keep investors interested over the long term.

After all, according to the Centers for Medicare and Medicaid Services, 17% of the U.S. GDP in 2023, or about $4.8 trillion, was spent on healthcare.

So, finding a therapeutic diamond in the rough can lead to significant returns. To evaluate these companies, we start by examining their drug pipelines.

Using our expertise, we assess the mechanisms of action of drug candidates and assign a probability of success based on their development stage and data generated to date.

For perspective, a preclinical asset might have a 1% to 5% chance of success while a drug under evaluation in end stage pivotal clinical trials could have up to an 80% chance of success.

Next, we determine the total addressable market by analyzing disease incidents and prevalence, pricing of similar drugs and the competitive landscape.

This helps us estimate peak sales in a given year.

We then discount back risk adjusted free cash flows considering typical pharmaceutical operating margins to arrive at a present valuation, price target and rating.

Other factors, including existence of pharmaceutical corporate partnerships and quality of management are also considered.

Essentially, while there's no perfect way to analyze development stage biotech companies, a thorough understanding of their drug pipelines and market potential can help uncover underappreciated investment opportunities and lead to significant investment returns.