Why biotech IPOs outperform the market standard

Biotech startups are proving to be an exception to the long-held belief that the stock market punishes tech companies that go public before they are turning a profit, CNBC reports.

A prevailing theory in Silicon Valley — where the focus is often on long-term success rather than short-term profits — suggests that when a startup continues to operate at a loss long after its initial public offering, public-market investors will withhold funding until the company changes management or makes some other purportedly profitable change.

In fact, this has not been the case for biotech companies, according to analysis provided to CNBC by Jay Ritter, PhD, a finance professor at the University of Florida's Warrington College of Business. Between 2001 and 2017, only 6 percent of biotech companies were profitable at the time of their IPOs, but the three-year buy-and-hold return rate for 350 newly public biotech startups during that time was 14 percent higher than the market standard.

Additionally, while biotech IPOs produce lower returns on average than the overall market, they still outperform other IPOs by several percentage points. The key, according to Dr. Ritter, lies in the credibility of their research, even as they face more regulatory obstacles and thus remain unprofitable longer than other tech startups.

"We've had hundreds of biotech companies going public in recent years where everybody knows that they're not going to have any revenue from product sales for years," Dr. Ritter said. "There's no pressure for them to cut their short-term losses — as long as they've got viable scientific research."

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