Rocket Stocks: Learn to Profit from Biotech’s Winners
For investors, there’s no better feeling than finding a little-known stock that takes off and rewards you with big gains in a relatively short period of time. In the stock universe, few types of stocks can make huge sudden moves like small biotechs.
The fate of these tiny biotech companies usually rely on one or two promising drugs in their development pipelines. Depending on changing expectations, clinical trial results and other news, their values can spike or plummet in the blink of an eye.
Because of their ability to quickly launch higher, these biotech “rocket stocks” attract aggressive investors. But these stocks also are volatile. Investors must be willing to shoulder risk and remain ready to jump ship at any time.
For an illustration of how a small biotech stock can take you on a wild ride, consider the following personal anecdote.
The Story of Mannkind
About five years ago, I came across a company called Mannkind Corporation (NSDQ: MNKD). The company had only one notable product in the clinical stage, inhalable insulin (Afrezza) that could be breathed directly into the lungs via a small device. The concept is that inhalable insulin is more convenient and less bothersome than a needle injection.
The product seemed quite interesting to me, so after looking into the history of the company and its founder Alfred Mann, I bought some shares in November 2012 at $1.95. As anticipation grew over positive clinical data, the share price quickly rose. I bought additional shares in May 2013 at $4.19. But knowing how biotech stocks’ momentum can suddenly change, I sold half my position a month later at $6.43.
Sure enough, even though the company reported positive clinical results, analysts expressed concern that the product may not be different enough from Pfizer’s (NYSE: PFE) Exubera to get FDA approval. The stock price fell as quickly as it rose.
You see, Exubera was an inhalable insulin drug that was abruptly pulled in 2007 due to weak sales and possible lung cancer risk. But Afrezza worked differently than Exubera and the Afrezza applicator was much smaller than Exubera’s clunky device. Despite the market’s concerns, I held my remaining shares.
The share price remained range-bound until an FDA advisory committee hearing on Afrezza approached and the share price started to rise. This hearing was expected to be a predictor of the FDA’s eventual decision. I sold more shares in April 2014 at $6.14, a couple of weeks before the scheduled hearing. I did this as a hedge in case the hearing went poorly. I kept some shares in case the hearing went well.
The committee ended up leaning toward recommending approval, and the share price rose over the ensuing weeks until the FDA approved Afrezza in June 2014. However, in what is known as “sell the news,” the stock price fell after approval.
FDA Approved; Now What?
This dynamic occurs because the key catalyst — FDA approval — has already happened. The idea is that the stock will need a new catalyst to move much higher. After approval, the major question is how to sell Afrezza. Mannkind didn’t have the sales team or the capital to launch a large marketing campaign. In hindsight, I should have sold all my shares as the FDA decision approached, but I felt confident that Mannkind could get a good marketing deal with a large drug company.
The good news is that Mannkind did find a partner, Sanofi (NYSE: SNY), but the bad news is that the terms of the partnership were disappointing to me. This was a huge red flag and I sold my remaining shares at $8.14 in August 2014, about 20% from the pre-approval peak.
(Note that the stock had a reverse 1-for-5 split in 2017. The prices I cite above are pre-split numbers.)
Flash forward to today. MNKD has cratered. It is trading at less than $2 a share. Adjusted for the reverse split, that’s less than $0.40 a share, a stunning 95% fall from when I sold all my shares (see chart below).
A combination of poor marketing, low insurance coverage, and a requirement that patients must get a lung test before buying Afrezza has resulted in extremely poor sales. The drug is generating only a little more than $10 million a year in revenue.
Lessons to Heed
What are the main lessons from my real-life experience?
1) Even if a biotech company eventually fails to come up with a big-time drug, it’s still possible to do well on its stock. The key is to understand what drives the stock and to know when to get in and when to get out.
2) You must manage risks. Don’t bet the farm. I made sure I took some profits off the table in 2013 even though I felt there was more upside to the stock. I was able to hang tight with my remaining position when doubts about FDA approval ran high because I did not have huge exposure to the stock. I was using money I could afford to lose to try to make big gains. During this time I also generated extra income by selling out-of-the-money calls on my MNKD shares.
3) “Buy the rumor” and “sell the news” often happen with biotech stocks. Excitement from anticipation of good clinical data or approval will attract buyers, but once those key catalysts occur, the momentum buyers usually sell and look for greener pastures. You need to know if you want to stay in for the long haul or if you want to hit and run.
4) Don’t be married to any stock. As much as I liked Afrezza’s potential, when I saw the disappointing terms of the deal with Sanofi I knew it was time to sell.
Understand small-cap biotechs for what they are: highly speculative investments with huge upside. Keep your eyes open and tread carefully. These rocket stocks can soar into the stratosphere, but they also can crash on the launch pad.
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