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Small-Cap Biotechs Pursue IPOs Fastest in Decade

NEW YORK ( TheStreet) -- Major rallies in the Dow Jones Industrials (^DJI) and the S&P 500 generated most of the headlines in financial news so far this year. But one of the lesser-discussed stories can be found in the performance of the biotech sector, which has seen its biggest year-to-date rally since its inception in the mid-1990s.

The Nasdaq Biotechnology Index (NBI) gained by 36% so far this year. There are six biotech companies in the S&P 500, and the average gain for the group is 40% -- even with this year's massive earnings disappointment from Amgen (AMGN - Get Report).

Gains like these would be understandable if there had been a significant medical advancement or a major drug release in the last few months. But since this has not been the case, some degree of caution is warranted.

The biotech industry certainly has a reputation for being one of Wall Street's riskiest investments. But it is clear that markets are waiting in anticipation of the next medical breakthrough. Broad interest in 10 of the sector's U.S. IPOs has generated early investments of nearly $750 million.

The focus of these companies centers on a wide range of areas, developing drugs for illnesses like hepatitis C and multiple sclerosis. The real reason behind this interest, however, might have more to do with the strong bullish sentiment supporting stocks as a whole than with the prospects for individual companies.

In fact, support for most of the clinical-stage biotechs hinges on the fate of a single drug, which adds to investment risk and begs the question of whether or not all this year's surge in interest is warranted.

Broader Sentiment in Stocks Supports Biotech

Widespread enthusiasm in stock markets this year has encouraged investors to take a chance on small biotech companies as they move forward in the hope of creating the next headline-grabbing medical miracle. Smaller biotech companies generally lack stable cash flow, and this means they tend to have a hard time working up interest from credit investors.

But these companies are now pursuing IPOs at the fastest rate in a decade, making up nearly 15% of all U.S. IPOs so far this year. Industry data shows that roughly one in 10 biotech companies are able to successfully launch and distribute one of its products, making investments in the sector a difficult practice. But when the right biotech companies are chosen, early investors can see substantial returns later on.

When we compare this year's performance in the Nasdaq Biotech Index (up 36%) to that of the S&P (up 18%), the possibilities for strong returns start to become clear. This year's performance in the Nasdaq Biotech Index surpassed the previous dotcom-era record, and doubled this year's bull rally in the S&P 500.
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