The other day I made a quick comment that I wasn't sure which would have a higher rate of return - biotech stocks or lottery tickets. Some folks liked the comparison, and others didn't, naturally. But there are some points worth thinking about in it.
For one thing, we have to distinguish between the gains realized by the companies themselves, versus those realized by their stocks. The former figures have already been calculated fairly recently (2004) by David Hamilton in the Wall Street Journal (subscriber link here), and I wrote about their figures at the time.
The best estimate was that since the first biotech company went public, total operating losses in the industry have amounted to some 40 billion dollars. Genentech and Amgen do what they can with all the black ink that they generate, but they're overwhelmed each year by the tide of the red stuff. I can only imagine what this figure would be if it included non-public biotechs, every single one of which (as far as I know) has run at a loss. After all, when you start to look like you're going to turn a profit someday, you're already public, right?
During this period, investors have put about 100 billion into the public companies, so we know where 40% of that money has gone, at any rate. Ah, but you're saying, these investors got stock in return, and how's that done, eh? Undeniably, some of the issues have made people fantastic amounts of money - Amgen, for example, has returned several hundred-fold on an investment at its IPO price in the early 1980s, although surely no human being has held it for that entire time. Of course, somewhere around 15 or 20 per cent of all the biotech companies that have gone public over the years turn out to have returned nothing at all, having disappeared in a blizzard of worthless stock, so that does cut into things. Still, biotech has been up over that time - but compared to what? As a whole, the article suggested, the sector has failed to even come close to the S&P 500's rate of return over the last 25 years. (And I'm not sure if that comparison includes transaction costs, which because of all the turnover in the sector would skin you alive over time).
So, how's that lottery ticket comparison look? If you're looking for the next Amgen or Genentech, well, those are two stocks out of several hundred that have gone public. Those are far better odds than the jackpot in a state lottery, true (although the jackpot has an even more insane rate of return). How about the overall odds of winning, though? Looked at more broadly, most state lotteries will cause you to lose about half of every bet that you put into them (a rate which casino operators can only envy). The figures above suggest that (on an operating basis), biotech has done worse, splitting about 41/59. On a stock investment basis, it appears that you'll make money overall, but not as much as you'd make by parking the same cash in the indices, and I'd call that a loss, myself. You may not think so, but if you don't, please send the difference to me so I can give it to Vanguard myself.
I should mention that the original WSJ article is itself full of comparisons to casinos, Las Vegas, and lotteries. The point, unfortunately, is well taken. Next time, we'll talk about probability of ruin, and things will really start looking grim.