Pre-clinical is the earliest stage of research in the development of a new drug, vaccine, or medical device. Think of it as the 'lab and animal testing' phase that happens long before any human testing is allowed. In this stage, scientists in the biotechnology or pharmaceutical industry work to answer two fundamental questions: “Is this new compound likely to be safe?” and “Does it show any signs of being effective against the target disease?” This research involves experiments in test tubes and petri dishes (known as in vitro studies) and subsequent testing in animal models (in vivo studies) to understand how the compound behaves in a living organism. The goal is to gather enough data to convince regulatory bodies, like the U.S. Food and Drug Administration (FDA) or the European Medicines Agency (EMA), that the potential treatment is safe enough to proceed to the first stage of human testing, known as Phase I trials. A successful pre-clinical phase is the ticket needed to file an Investigational New Drug (IND) application and move into clinical trials.
For investors, the pre-clinical stage is the wild frontier of life sciences investing. Companies at this stage are often small, research-focused outfits with no products on the market and, therefore, no revenue. They are a high-stakes bet on future scientific success. The risk is immense; the vast majority of compounds that look promising in a lab will fail pre-clinical testing. They might prove to be toxic to animals or simply not have the desired effect.
Investing in a pre-clinical company is a form of speculative investment, closer in spirit to venture capital than to traditional stock investing. These companies are often funded by angel investors and early-stage funds because their future is entirely uncertain. The stock price of a publicly-traded pre-clinical company often hinges on a binary event—a single piece of news, like the release of key animal study data or the FDA's decision on an IND application.
Since you can't use standard financial metrics like a P/E ratio, your due diligence must focus on different factors. You're not buying a business; you're funding a scientific experiment.
From a classic value investing standpoint, pre-clinical companies are usually un-investable. Their intrinsic value cannot be calculated with any degree of certainty because they have no history of earnings or stable cash flows. Their value is based almost entirely on expectations for a future that may never materialize. Warren Buffett famously advises investors to “never invest in a business you cannot understand.” For most people without a Ph.D. in molecular biology, the intricate science behind a pre-clinical drug candidate falls squarely into that category. Investing here is a bet on a scientific breakthrough. While the potential rewards are tantalizing, the probability of a total loss is exceptionally high. For the average investor, this is a territory best observed from a safe distance.