The biotech sector has seen some serious momentum lately.

Take Pfizer (PFE), which just bought Wyeth (WYE) for $65 billion dollars, or Bristol-Myers Squibb (BMY), which publicly said that it is looking to invest about $8 billion into the biotech space.

Over the last three months, shares of biotechnology firms Geron (GERN) and StemCells (STEM) are up roughly 200%, compared with a decline in the S&P 500 of almost 5% and a decline in the Nasdaq Biotechnology Index of about 3%.

So why have both names massively outperformed the boarder market?

First, it’s important to know that both Geron and StemCells are biotechnology companies that specialize in the area of stem-cell research.

Starting in late October and early November of 2008, a confluence of several positive events started to take place. First, it became quite clear to the markets that Democratic presidential candidate Barack Obama had a substantial lead over Republican candidate John McCain. Historically, Democrats have favored stem cell testing and research more than Republicans, who have only supported partial stem cell testing and research.

On Jan. 23, 2009, Geron won approval from the Food and Drug Administration to begin a very limited embryonic stem cell test in humans. From 2000 to 2008, Geron had been testing solely on animals.

Furthermore, news of possible loosening of past government restrictions formed by the prior administration helped fuel these stocks higher.

Geron’s now-FDA-approved phase I test will attempt to use stem cells to restore movement to paralytics with injections of nerve cells made from embryonic cells.

Over the past several years, thousands of patients have been treated with stem cells and have show rather mixed results, but no human have been given cells derived directly from embryos. Geron’s now-approved trial attempts to do just that.

Sounds like groundbreaking stuff right? Quite frankly, it is.

But before one goes out and buys Geron or StemCells, there are several important things to realize:

1. This is a phase I trial for Geron that will include 10 human patients. Typically, more than 90% of all phase I testing never meet their final end points.

2. Such trials take years. Then you have phase II testing, which also take years, then phase III testing. While the tests providing useful data, they also take time and money, something money-losing biotech companies cannot really afford

3. There's a high burn rate for both firms. Geron is burning cash to the tune of $50 million per year, while StemCells only has $20 million of cash on hand.

4. Both companies are likely to issue equity in the future to help current financing issues.

5. Geron’s CEO is a hype machine. On Friday of last week, he appeared on CNBC and Bloomberg Radio, had a New York Times article written about the company and hosted an investor's conference call -- all for a company that is entering a small phase I testing!

So, while both companies certainly have promising futures, there are still several unknown variables that could take the short-term momentum out of both names.

For more biotech ideas, including Amgen (AMGN) and Genentech (DNA), check out the Rocket Biotech portfolio on Stockpickr.

If you don’t have time to follow the biotech sector like a hawk, than treat yourself to Adam Feuerstein’s Bio-Tech Select Portfolio.

Posted on Feb. 2

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