Biotech is one of the few industries that I almost never look at (except once a year on the short side), so take this with a grain of salt.
Biotech stocks are among the least efficiently priced in the market because of the binary nature of the outcome (usually). Typically a probability valuation is used instead of a DCF approach. You might look at the estimated size of market for a drug with a range of estimates for how much penetration (if green field) or market share (if planning to enter against incumbents) the company’s drug or product could achieve. The actual profitability of the company is less important than the sales figure (because most companies get sold if they have a winning drug, and then become part of larger, more efficient operating structures). So a multiple of sales of based on the estimated potential sales of the drug is appropriate.
If, for example, you think that the potential size of market is $100M and there is a 50% chance the drug catches on, the upside market cap would be $50M (100 * 50% + 0 * 50%) – assuming the stock is worthless if the drug never catches on. You would, of course, adjust that for the cash on hand (as a function of the estimated burn rate). I don’t really see people discounting the forecast back because the probability is sort of an all encompassing discount rate anyway.
So as you can see, there could be a huge range of value, and that’s one of the reasons the stocks are so volatile. I am not really sure how anyone estimates the probabilty part of the equation since they always seem like long shots to me, but obviously it depends on what stage the drug is in and a bunch of other factors. There are some really crazy sophisticated hedge funds that hire independent medical teams and consultants (and probably pay people for inside info as well) that try to derive an edge that way – you and I probably don’t stand a chance, and you are probably better off focus on operating companies instead of R&D companies if your goal is to learn how to invest.
But if your question is, do real options have value? Then the answer is definitely yes, and that comes up across many industries / situations. I tend to just estimate the impact of the option on the company’s fundamentals and igore any esoteric models or whatever (most people don’t ever look at that stuff).