Investors today are participating in an investment boom of historic proportions, particularly in the Internet sector. While Internet stocks have experienced some recent weakness as compared to their recent 52-week highs, stocks like Amazon.com and eBay continue to trade at many times their 52-week lows and year-ago prices. Biotech, however, is another sector that once again has its proponents and momentum among investors. For example, biotech leaders like Amgen are trading at or near 52-week highs.

Understanding biotech’s past should be a requirement for today’s Internet investors. At the same time, however, understanding the Internet’s present boom may foreshadow a bright future ahead for biotech. In the 1980s and again in the early 1990s, biotech stocks experienced gains that may be analogous to the Internet sector returns that we have witnessed over the last several years. Consequently, analysts have compared the folly of previous biotech cycles to the present mania for technology investment opportunities. Analysts point out that each previous biotech boom has been followed by a successive bust resulting in significant losses and disillusionment among investors, implying that Internet investors are in for a similar fate.

Biotech 101

Like the Internet today, biotech investment opportunities in the early 1990s captured the imaginations of a broad base of investors. Also like the Internet, biotech was initially largely funded by individual retail investors and was scorned by the majority of institutional investors that regarded the sector and its companies as too speculative and difficult to value. However, as enthusiasm grew, institutional investors also piled in, driving valuations even higher and simultaneously perpetuating and validating the mania.

Since investors rely primarily on their expectations of the future, valuations were driven skyward by hopes of quick progress. Companies went public well before having products or distribution channels or business plans. At the height of the mania, all it took was a few PhDs in biotech, a sexy mission such as finding the cure to cancer or AIDS, and some patent filings or research claims. Venture capitalists were, of course, eager to fund biotech startups, anticipating quick returns when these companies went public, often within 12 to 18 months of inception and often at valuations representing many multiples of the original investment. At some point it became clear to investors that creating a successful drug and bringing it to market was much more difficult than expected. Each time, this realization resulted in a quick deflation of the previous valuations.