When I first broached the idea for this article with my editor and fellow writer Tom Richardson, he pointed out that a 'Medical/Biotech Stocks for Beginners' article was an oxymoron, since speculative biotech stocks are definitely NOT for beginners.
However I think it's safe to say every investor has felt the temptation to chase jackpot returns in either biotech or mining stocks, and with major companies like Sirtex Medical Limited (ASX: SRX) and Acrux Limited (ASX: ACR) still conducting clinical research, knowing what experimental results actually mean can be a valuable skill.
And when I say valuable I mean literally, either keeping or putting dollars in the bank for you.
This will be a multi-part work on examining biotech stocks, as there is simply too much information to distil into a 600-word article.
Let's get right to it, using the example of Cynata Therapeutics Ltd (ASX: CYP), whom I wrote about last Friday. Despite soaring 80% that day, the company's drug projects are in the very early phases of testing – in fact, they haven't even been tested on humans yet.
With up to four phases of drug testing, shareholders have a LONG way to go before any therapies become mass-marketable.
Medical and pharmaceutical therapies generally follow five stages:
Animal testing
Although some may find it unpalatable, this is often the earliest stage in developing drugs to support human health. Therefore, drugs or therapies are tested and refined on various animals – rats, mice, and so on – to examine their usefulness before progressing to human trials.
An example of animal testing comes from Cynata's website:
20 mice had a major artery in their hind leg surgically removed. Half were injected with saline and the other half with Cynata's proprietary Cymerus stem cells, and the subsequent return of blood flow to the hind leg was measured over a number of weeks. Cymerus was found to be significantly more effective than saline.
This success paves the way for human tests, although there will be no artery removals permitted in those test subjects.
Phase I – initial human tests
Researchers test a new drug or treatment in a small group of people to determine dose ranges and evaluate safety and side effects, as well as measure results.
Typically this is a small group of 'available' clients (such as those already known to the researchers as a result of their condition) and often numbers less than 20.
There can be a problem with results due to bias in this phase, as sometimes only the most severe sufferers of a condition become test participants. Individuals with less severe symptoms are often already treatable with other drugs, while those with intractable symptoms engage in testing as a 'last resort'.
This raises the question of effectiveness, as who is to say a drug is not more or less effective in more severe patients as compared to 'average' ones?
A perfect example of Sirtex conducting Phase I testing can be found at the ASX website, here.
Sirtex recruited twelve patients to test the effectiveness of its SIR-Spheres in treating kidney cancer. Four levels of radiation doses were tested on three patients each, and the study established that there was no SIR-Sphere related toxicity in those patients.
Following successful completion of this test, Sirtex chief investigator Professor Paul de Souza announced: 'We now need to examine additional higher radiation dose levels and look forward to defining the optimum radiation dose to take forward into a definitive trial.'
Which leads us perfectly to the next stage of research:
Phase II – experimental evaluation
This is the first real test of a treatment, as it involves a larger sample size (number of participants) which is better for generalising the results to a population.
More expensive and time consuming than Phase I, this is usually not a simple repeat as researchers will try to improve or test more aspects of the therapy.
If the treatment is deemed successful and safe at this stage, there's a fair chance it will make it through phase 3 and into production.
Phase III – comprehensive clinical testing
This is where a treatment really goes through the ringer, with large, representative sample sizes and rigorous comparisons to existing treatments.
Side effects and information on target 'audience' (which patients to use the treatment on) are measured. Other variables including age or gender, weight, severity of condition, contra-indications (when the treatment should not be used) and so on are comprehensively compiled and analysed in the trial.
We turn to Sirtex again for a solid example of a third phase test here, where the company aims to determine if combined chemotherapy plus SIR-Spheres is more effective than chemotherapy alone in combating bowel cancer.
Phase III is generally the most expensive and time consuming stage, although that depends a lot on the type of therapy being developed.
Following trial completion, a company will generally be able to secure regulatory approval, though this is far from guaranteed and may require further testing.
Phase IV
This phase doesn't occur until after a drug enters the mass market. Further research and all kinds of data and analyses are collected and conducted on the drug to improve the collective knowledge around its use.
This is generally not relevant to listed companies, however adverse findings or revelations of falsified data – as happens occasionally at big US pharmaceutical companies – can be a major surprise hit to share prices and earnings.
So there you have it, a basic introduction to the five stages of drug testing.
In the next part, I'll be introducing other useful information on sample sizes, statistical significance (p</=0.05), and the hidden dangers of correlation.
What did you think of the article? Was there anything I missed you'd like to know more about in a future version?
Until then, invest Foolishly and check out The Motley Fool's free report on their Top Stock Pick for 2015!
