Clinical Trials: The Stages and What to Look For
Understanding clinical trials is crucial if you are interested in investing in pharmaceutical or biotech stocks. These trials are the make or break for a company in this sector, so you need to get your head around them.
Even the most exciting treatments with massive Total Addressable Markets (TAM) are meaningless without successful trial data to back them up.
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Clinical study papers and company announcements related to clinical trials are full of technical mumbo jumbo. So let’s look at the key terms and what they really mean.
Primary Endpoint: The main result that a study is designed to measure to determine if the treatment is effective. This could be the reduction of a symptom, the complete eradication of a disease, or any other significant change.
Secondary Endpoint: Additional results used to evaluate other effects of the treatment. These can support the primary endpoint or show additional benefits.
Pharmacokinetics (PK): The absorption, distribution, metabolism and excretion of a drug in the body. A blood testing schedule is usually used to measure drug levels in the body over time. Can be used to determine correct dosages.
· Absorption: How the drug enters the bloodstream.
· Distribution: How the drug spreads through the body's tissues.
· Metabolism: How the body breaks down the drug.
· Excretion: How the drug is eliminated from the body.
Pharmacodynamics: How a treatment affects the body. It encompasses the mechanisms of drug action and the relationship between drug concentration and effect, including both therapeutic effects and side effects.
Maximum Tolerated Dose (MTD): The highest dose that does not cause unacceptable side effects. It helps to determine safe dosage levels.
Direct Contribution: In clinical trials, direct contribution refers to the measurable impact of a specific intervention or treatment on the outcome of interest.
Net Selling Price (NSP): Net selling price refers to the amount the drug is sold for after deducting any discounts, rebates, or allowances.
DX: Diagnosis. Sometimes used as a population of patients diagnosed with a disease.
RX: Prescription. Sometimes used in company reports as the number of prescriptions sold.
Drug-Drug Interaction: When the effects of one drug are altered by the presence of another drug, which can lead to increased or decreased effectiveness or adverse effects.
Bioavailability: The proportion of a drug or other substance that enters the bloodstream when introduced into the body and can have an active effect. Bioavailability is influenced by the drug formulation and the route of administration (e.g., oral, intravenous), and is a key consideration in drug development.
Bioequivalence: Refers to the comparison between two pharmaceutical products that have the same active ingredient, showing that they have similar bioavailability and produce the same effect at the site of action.
Adverse Event (AE): Any undesirable experience associated with the use of a medical product in a patient.
Placebo: A substance with no therapeutic effect used as a control in testing new drugs.
Double-Blind Study: A study in which neither the participants nor the researchers know who receives the treatment versus the placebo, reducing bias.
Randomized Controlled Trial (RCT): A study in which participants are randomly assigned to either the treatment group or the control group, considered the gold standard in clinical research.
In Vitro: Testing performed on cells in a laboratory.
In Vivo: Testing on live animals such as monkeys and mice.
The Four Phases of Clinical Trials: Breaking it Down
Clinical trials are conducted in four distinct phases, each designed to answer specific questions about the treatment.
Multiple trials can be conducted within each phase. Each trial will have specific targets, which will inform future trials and, finally, regulatory approval.
Let’s break them down one by one.
Preclinical Testing: The First Hurdle
Before a drug even reaches the clinical phases, it undergoes preclinical testing. This can include studies on cells (in vitro) and animals (in vivo) such as mice or monkeys.
These early tests check for basic safety and biological activity. If the results look promising the drug moves on to human trials.
Phase 1: Is it Safe?
The first hurdle for any new treatment is safety. This phase aims to determine the strongest dosage that a human can take without unacceptable side effects. The sample size here is generally small, at about 10-100 people.
It’s common to use healthy (free of the target condition) participants, as it’s easier to track adverse events in healthy participants.
However, sometimes for the treatment of life threatening conditions, terminally ill patients will be used instead. This is generally where very serious side effects are accepted as it is better than letting the disease run its course.
For example, patients with terminal cancer will likely accept potential kidney damage or extreme nausea if it extends their life by a few years or potentially offers a cure.
This stage often includes a pharmacokinetic study to determine beneficial dosing levels.
Usually, two or more dosage levels are used and measured in different groups to determine their absorption, duration in the body and side effects. A pharmacokinetic study can involve gradually increasing dosages until adequate absorption and duration is achieved or side effects become too severe.
Phase 1 trials generally involve a high degree of monitoring to determine side effects and the drug's lifespan in the system. So, there could be regular blood and urine testing, as well as scans and verbal feedback from the subjects.
This stage may also be used to determine the form in which a substance is administered to patients. The drug may be injected directly into a vein, taken orally (as a tablet or liquid), or applied to the skin as a topical gel. Different forms may not always be possible. But, when they are, researchers want to determine the ideal form early, as side effects and absorption can vary largely.
Phase 1 trials have a 50-70% chance of success. The main focus is safety, Maximum Tolerated Dose (MTD) and side effects.
Phase 1 trials can be split into 1A and 1B. There are several differences between the two.
Phase 1a
Phase 1a trials are Single Ascending Dose (SAD) studies. That means participants are given a single dose of the treatment and then monitored. If side effects are within tolerance then the dosage is increased.
This is repeated with increasing dosages until the Maximum Tolerated Dose (MTD) is reached. This is usually the point where a third of all participants experience severe side effects.
At every dosage level, the pharmacokinetics are monitored.
Phase 1b
Phase 1b trials are Multiple Ascending Dose (MAD) studies. Instead of a one off dose, participants are given repeated doses of the same strength at regular intervals.
The idea here is to create a routine similar to how a patient would use the treatment in real life. Repeated dosing will help determine any accumulation in the body over time for both safety and drug presence.
The study will involve multiple groups receiving different dosage levels so that the differences in side effects and drug presence in the body can be compared. These various groups can be run at the same time or in sequence.
Phase 2: Does it Work?
Here it’s all about effectiveness.
Trials expanded to a larger population of subjects (usually several hundred) with the condition targeted by the treatment.
This is where researchers start testing if the treatment works under real world conditions.
Data on safety is expanded at this stage to include specific condition sufferers instead of just healthy individuals. After all, treatment must be of net benefit, or there’s no point in it.
Phase 2 trials have a 28.9% chance of success. This is certainly a tough hurdle.
This stage does a lot of the heavy lifting, making it one of the most critical phases for investors to position for. The main focus is on how well the treatment works and on safety.
Phase 3: Comparative Efficacy
At this point, the drug is being tested on hundreds to thousands of patients to compare how well it works compared to existing treatments or a placebo.
A treatment having a positive impact isn’t enough.
If a new drug reduces epileptic seizures by 10%, but there are existing drugs that reduce it by 80% without notable side effects, then it makes sense that the new treatment is not very useful.
Phase 3 trials have a 50-70% chance of success. The main focus is on comparative efficacy.
Phase 4: Post Approval Monitoring
The last phase of clinical trials is after approval. This is where an existing available treatment is studied for effectiveness and side effects in the general population.
This stage includes studying data from patient registries, health insurance companies and Electronic Health Records (EHR).
While often overlooked, phase 4 is just as critical as new issues can arise that aren’t picked up in the pre-approval phases.
Chances of Success
Many factors influences a treatment’s chance of successfully hitting the desired end points.
About 13.8% of all treatments that enter clinical trials pass each phase and receive regulatory approval. Any one treatment has a very low chance of running this gauntlet of death.
So, it’s important to size bets accordingly.
The following table shows the chances of a treatment progressing through a stage based on the treatment area.
Success rates by disease and phase (Source: Biotechnology Innovation Organisation)
At the very minimum this should get you thinking about risk reward. If you’re currently eyeing a company with an Autoimmune drug candidate that’s pre-phase 2 trials, you should be running some rough numbers.
Autoimmune treatments have a 31.4% chance of passing phase 2 trials, a 65.3% chance of passing phase 3 trials, and a 94.1% chance of approval after all trials are done.
So, at this pre-phase 2 trial phase, any given treatment for Autoimmune diseases has a 19.3% (31.4% x 65.3% x 94.1%) chance of achieving approval.
Let’s assume a 40% EBITDA margin and that it can achieve 30% TAM share within five years.
If the treatment has a Total Addressable Market of $500 million, then we have $150 million share as revenue, flowing to $60 million in EBITDA per year after 5 years.
With a 19.3% chance of regulatory approval, this potential $60 million equates to an expected $11.6 million.
Probability is cold and harsh.
If we want to make sure we are really getting paid for this risky investment, and we target a 5-year forward Market Cap/EBITDA of a maximum of 3X. We’d only be willing to buy into this company if its market cap was $34.8 million or less.
Before you scream about Enterprise Value over Market Cap, the pitfalls of EBITDA, or the virtues of a DCF analysis, please understand that this is a simple demonstration.
Let’s take it a step further and say the treatment passes phase 2, and is now pre-phase 3.
Now we have a whole different ballgame.
Suddenly, we have a 61.4% chance of success and an expected annual EBITDA of $36.9 million.
A 3X multiple now lands us at a market cap of $110.6 million.
Suddenly those big jumps in a share price after clinical trial results make a lot of sense.
I encourage you to explore the numbers and build your models for valuing companies through the clinical trial life cycle.
Pathways and Jurisdictions
There are many different pathways to regulatory approval. At the highest level, it's important to understand if the product is a treatment/medicine, a medical device, a vaccine, or a test or diagnostic.
New Drug Application (NDA)
After the conclusion of phase 3 clinical trials, we want evidence that a treatment is beneficial and safe. If the evidence isn’t clear, the drug owner can either re-design studies using the learnings from the existing trials to target different applications or treatment routines or drop the treatment as something proven to be ineffective or unsafe.
If, on the other hand, there’s compelling evidence of a beneficial effect, the treatment can be moved toward regulatory approval. In the US, this process is called an NDA.
It’s a submission to the FDA seeking approval to market and sell the treatment in the US as a treatment for specific conditions.
The NDA submission will seek to convince the FDA of four elements of the treatment for the specific condition:
The Drug is Safe: Adequate data must be provided to confirm that the drug does not pose undue risk to patients.
The Drug is Net Beneficial: The drug's positive effects must outweigh any negative effects for the targeted condition.
The Labeling, Instructions, and Packaging are Appropriate: Clear and accurate information must be provided to ensure safe and effective use.
Manufacturing Composition, Design, and Controls are Adequate: The manufacturing processes must ensure that the drug can be consistently produced at the required strength and quality.
NDA submissions can be quite comprehensive, involving detailed information about all aspects of the drug’s development, testing, and production.
Biologics License Application (BLA)
This is specifically for biologic products, such as vaccines, blood products, and gene therapies.
A BLA requires similar data to an NDA but focuses on biologics’ unique properties and their production.
Abbreviated New Drug Application (ANDA)
This pathway is for generic drugs, which must demonstrate bioequivalence to an already approved drug.
The ANDA process allows for a more streamlined review, as the FDA has already assessed the safety and efficacy of the reference drug.
Medical devices
The pathway to approval for medical devices varies based on the classification assigned to the device. Devices are categorized from Class I to Class III based on their risk level and the degree of regulatory control required to ensure efficacy and safety.
Class I: These devices are generally exempt from premarket submission and are considered low-risk. Examples include bandages and examination gloves.
Class II: A premarket notification, known as a 510(k) submission, is required. This submission demonstrates that the device is substantially equivalent to a legally marketed device. Certain controls, such as performance standards and post-market surveillance, apply to Class II devices. Examples include infusion pumps and X-ray machines.
Class III: These devices are high-risk and require a premarket application (PMA). The PMA process is rigorous, involving substantial clinical data to demonstrate the device's safety and effectiveness. Examples include implantable devices and life-supporting systems.
De Novo Classification
These are devices that have never been sold within the US, but are well understood.
It allows for a streamlined review process for novel devices deemed low- to moderate-risk.
Humanitarian Device Exemption (HDE)
This pathway is for devices to treat or diagnose diseases that affect fewer than 4000 people per year in the US.
It provides a simplified process for devices that address unmet medical needs.
Laboratory Developed Tests (LDT)
Laboratory Developed Tests (LDTs) are a unique category of diagnostic tests created, developed, and used within a single laboratory.
Unlike traditional diagnostic tests, which are subject to pre-market review by regulatory bodies, LDTs are primarily regulated under the Clinical Laboratory Improvement Amendments (CLIA) program, overseen by the Centers for Medicare & Medicaid Services (CMS).
Key Features of LDTs:
In-house Development: LDTs are designed and used in the same laboratory, tailored for specific medical conditions or patient populations.
Exempt from Pre-market Approval: Unlike medical devices and traditional diagnostic tests, LDTs have historically not required FDA pre-market approval, though this may change based on evolving regulatory oversight.
High Complexity: LDTs are often used for rare or complex conditions that may not have commercially available tests. This makes them critical in specialized medical settings, like cancer diagnostics, genetic testing, and precision medicine.
FDA Oversight (Evolving): Although historically regulated under CLIA, there has been growing debate about the need for increased FDA oversight. The FDA has proposed regulatory frameworks to ensure the accuracy, safety, and effectiveness of LDTs, but these discussions are ongoing.
Why It Matters for Investors: LDTs represent an important opportunity in the diagnostics market, particularly for personalized medicine and genomic testing. However, the regulatory landscape is in flux, and increased FDA involvement could affect the time and cost of bringing these tests to market.
Special Designations
Orphan Drug Status: For drugs that treat rare diseases affecting fewer than 200,000 people in the US. This status provides incentives like tax credits and market exclusivity.
Fast Track: For drugs that treat serious conditions and fill an unmet medical need. It allows for expedited review and can facilitate more frequent communication with the FDA during the development process.
Breakthrough Therapy: For treatments that show substantial improvement over existing therapies for serious conditions. It includes all the Fast Track program features plus more intensive FDA guidance.
Investigational New Drug (IND) Application
An IND comes before clinical trials. It’s for US based trials, and is an exemption to distribute a non-approved treatment for purposes of clinical trials. In other words, it’s an application for FDA approvals to trial a new treatment.
After IND submission, it generally takes 30 days before the trial can commence. The FDA might issue a “Clinical Hold” if the trial design isn’t satisfactory. This is an indefinite delay that would only be released on the FDA being satisfied of required changes or clarifications.
An IND is commonly supported by pre-clinical data, that is to say studies based on laboratory cells or animals. So, you can think of pre-clinical as pre-human trials.
The data submitted includes:
Animal Pharmacology and Toxicology Studies: Demonstrating the drug’s efficacy and safety through animal testing.
Manufacturing Design and Controls: Detailed information about the drug’s composition, stability, and the manufacturing processes to ensure quality and consistency.
Clinical Trial Design: This includes comprehensive protocols, safety measures, and the qualifications of the clinical investigators who will conduct the trial.
There are three types of IND:
Investigator IND: This is submitted by a physician or investigator who intends to administer the drug to patients under their care.
Emergency Use IND: This allows for the use of an unapproved drug in a medical emergency where no alternative treatment is available.
Treatment IND: This is for drugs that are under investigation but may benefit patients with serious or life-threatening conditions
Beyond the FDA
While the FDA is the primary regulatory body in the U.S. for drug and device approvals, other regions have their own regulatory frameworks.
Australia: The Therapeutic Goods Administration (TGA) oversees the regulation of medicines, medical devices, and other therapeutic goods, ensuring they meet safety and efficacy standards.
Europe: The European Medicines Agency (EMA) is responsible for the scientific evaluation, supervision, and safety monitoring of medicines in the EU. The EMA operates on a centralized process for drug approvals, allowing a single marketing authorization valid across EU member states.
Understanding the diverse pathways and regulatory bodies involved in drug and device approval is essential for navigating the complexities of bringing new treatments to market. While the U.S. remains a primary focus for many companies due to its lucrative market opportunities, global markets hold significant potential as well.
Final Thoughts: Navigating the Risky World of Biotech
We’ve covered a lot of ground here, but if you’re serious about investing in biotech or pharmaceutical companies, this is just the start.
Clinical trials are the lifeblood of this sector, and understanding their phases, success rates, and the regulatory pathways is critical to making smart investment decisions.
The bottom line is that you need to understand the numbers, the risks, and the reward potential at each stage of the clinical trial process. Dig into the data, build your models, and make sure you’re positioning your investments to get the best payoff for the risk you’re taking.
Biotech investing isn’t for the faint-hearted, but if you’re willing to do the homework, the rewards can be huge.