The healthcare sector is my favorite sector to invest in, both for the long and short term.
Long term, demographics practically ensure that the sector will remain healthy (pun intended) for years to come. Every day, 10,000 baby boomers turn 65. A few decades from now, when the baby boomer population has dwindled, the next large population group (millennials) will be middle-aged.
Short term, few sectors have the ability to produce such strong gains as healthcare, particularly biotech. But with these types of small cap biotech companies, it’s easy to break one of investing’s cardinal rules: Don’t fall in love with a stock.
My brother worked in the movie industry. Sometimes he was under a lot of pressure. When he felt stressed, he reminded himself, “You’re either curing cancer or not curing cancer.” In other words, people wouldn’t die if his project wasn’t successful.
When you invest in small cap biotech stocks, you’re often investing in companies that are trying to cure cancer, diabetes or a rare but fatal disease. The work that these companies do is important.
If you buy shares of a stock like Target (NYSE: TGT), of course you want the company to prosper. And if Target’s sales are strong, it will employ more people and help grow the economy. All good things. But let’s face it, you probably don’t get that excited about the same-store sales report each month.
But when you invest in a small biotech, it’s different. It’s easy to become emotionally attached.
For example, consider a company like Seagen (Nasdaq: SGEN), which is developing therapies for treating various cancers, including lymphoma, breast cancer and cervical cancer. You want the company to succeed, not only for your own monetary gain but because of the impact it could have on hundreds of thousands of lives.
If things go wrong with some of these companies – like their drug getting rejected by the Food and Drug Administration (FDA) or their clinical trial data being weak – investors often make excuses and justify why they should stay in the stock, even if they have a large loss and the medical studies say the drug clearly doesn’t work.
And when things go right, they can go right in a hurry.
Mersana Therapeutics (Nasdaq: MRSN) is a great example of how biotech stocks can experience big swings.
The company’s lead drug upifitamab rilsodotin (UpRi) relies on antibody-drug conjugates to treat ovarian cancer.
On April 26, Mersana’s stock traded for $3.89. Due to promising data on ovarian cancer from ImmunoGen (Nasdaq: IMGN), the stock took off and eventually peaked at $9.62 on June 12. On June 15, Mersana announced that the FDA had paused enrollment in two studies on UpRi due to five deaths caused by excessive bleeding. The stock quickly came back to earth. By June 21, the stock closed at $2.98. Then, on July 27, Mersana announced more bad news regarding its studies on UpRi, and the stock fell from $3.91 to an intraday low of $0.80 the next day. As I write, the stock trades for around $1.30, roughly a third of where it was four months ago.
Investors who were able to ride the stock to a high should have checked their emotions at the door and set a trailing stop.
I recommend a 25% trailing stop on most stocks, meaning you adjust your stop higher as the stock goes higher. When Mersana hit its high at $9.62, an investor who set a 25% trailing stop would have gotten out at $7.21, which would’ve saved them about six points based on where it’s trading today.
It would have been easy to get caught up in the emotion of rooting for UpRi. The American Cancer Society estimates that nearly 20,000 women in the United States will be diagnosed with ovarian cancer in 2023. Of those diagnoses, about 13,000 will prove to be fatal. It makes sense to root for a product that can be beneficial to so many people.
But setting a stop 25% below the high would have taken the emotion out of the trade and forced the sale of the stock at $7.21. Even if an investor was very hopeful that UpRi was going to save lives and be the next big thing in medicine, the stop would have taken them out of the position and saved them a lot of pain when Mersana tanked.