How to Play Stem-Cell Research Stocks

There are several different perspectives when it comes to investing in biotech stocks. One is that you can be a daytrader and ride the momentum, jumping off when the gas runs out. Or you can be it in for the long haul as an investor.

And when I say investor, I mean someone who has the patience to see new drugs enter the market, help patients, and translate into lucrative profits for the company that developed them. With earnings and time, the biotech company's share price appreciates.

On the other side, there are the short-term biotech players who enter the market somehow believing that buying a stock aids a company directly in its research. Instead, a domino effect may occur as a company's share price starts to move up, and investing in a stock merely becomes a transfer of money from one shareholder to another.

Unfortunately, this doesn't generate cash for the company to use for research and development. So in my opinion, it's best to buy a biotech stock when there isn't so much attention focused on the company, rather than getting too caught up in a story.

Take, for example, shares of stem-cell research companies that have made gains recently after privately held Advanced Cell Technology announced that it had successfully cloned human embryos. The news sent investors rushing into the biotech sector, snapping up stocks such as Geron, StemCells and Aastrom Bioscience that could benefit from the new scientific development.

Personally, I find stem-cell technology fascinating. Still, I'm extremely cautious about stem-cell companies as an investment because the technology is still just emerging. No therapeutics have yet been developed from this technology to treat diseases. And if there are any compounds in clinical trials, they are in a very early stage of development.

Since the wait will be lengthy for the technology to mature and to treat or cure disease, investors must have patience and tenacity. As you know, there aren't too many investors out there who fit that profile.

Besides the wait, stem cells carry some significant baggage. Do you remember the political and religious questions related to stem cells that President Bush had to consider before making his decision about increasing federal funding for stem-cell research back in August? These two considerations can hinder the progress for U.S. innovation before stem cells have an opportunity to prove their medical applications.

Consider, for instance, if the technology could regenerate body parts that no longer work. A new pancreas would be a priceless cure for patients with diabetes.

But investors who put money into these types of pioneering companies and try to figure out what the technology is worth are in a precarious position. The details of a biotech firm's business, its research methods, its test results, and even the products themselves can be highly complex. Compounding the issue is that the success or failure of a drug during clinical trials is often impossible to predict.

Thus investing in biotechnology stocks is different from investing in typical stocks, because when valuing biotech stocks, you can't use typical approaches such as calculating net present value and discounted cash flow. This is particularly true for the clinical and preclinical stage companies.

Predicting whether a single product will succeed in the clinical stages depends on many variables such as the trial design, the difficulty of indication and the quality of Phase II data. In addition, the company's financial health and corporate partnerships may further complicate the valuation analysis.

With regard to stem-cell companies, Geron is probably the leader of the pack. The company has a treasure chest of patents that specifically deal with stem cell technology.

Unfortunately, it's hard for me to be enthused about Geron, because patents don't mean the company will be successful in the long run. So, for the moment, I consider companies that specialize in stem-cell research to be risky and highly speculative.