Small-Cap Biotechs: How to Separate The Contenders From The Pretenders
Thursday, May 7, 2009
by Marc Lichtenfeld, Senior Analyst, Smart Profits Report
I’m used to explosive gains in the biotech world, but I’ve never seen a moonshot quite like this…
Shares of Vanda Pharmaceuticals (Nasdaq: VNDA) rocketed up by 625% today on news that the company’s schizophrenia drug, Fanapt, was FDA-approved. Earlier, the stock had opened at $9.99, having closed at $1.08 per share on Wednesday night - a massive 825% spike.
Even for a biotech veteran like me, a one-day percentage move like this is unprecedented.
But that’s the thing about FDA approvals for small-cap biotech companies. They’re huge catalysts for the stock in question. Unfortunately, separating the contenders from the pretenders is a tricky job. And even when you reel in a big winner, you need to know when to dash off with the money. Here are some tips…
Popping the Champagne on Small-Cap Biotechs
No doubt some VNDA investors are popping champagne corks today, following the small-cap biotech’s liftoff. It’s probably made their year.
Others, however, are still trying to recoup their losses from the stock - even after today’s monumental surge. That’s because two years ago, VNDA was trading around $25.
As the resident biotech expert here, I wouldn’t be surprised to receive e-mails asking why I didn’t recommend VNDA.
- When I first looked at the company three years ago, I thought the story was interesting. But the risk was just too high.
- My pessimism was right, as shares plummeted.
- And despite today’s news, it was only last summer that the FDA rejected Fanapt, saying that it was too similar to other drugs on the market. The stock dropped below $1.
Things got so bad that the stock was trading below its cash value and activists were demanding that the company be liquidated and cash returned to shareholders.
The bottom line is this…
Small-Cap Biotech Investing - The Risk-Reward Ratio Is Critical
Small-cap biotech investing is risky. I want to lower that risk whenever possible. That doesn’t mean I’ll avoid risk all together - on the contrary.
But what it does mean is that any position that I enter will have significant upside potential to offset that risk. The more risk… the more profit potential I need to recommend the stock.
As I mentioned, FDA approvals are obviously major catalysts for small biotech companies. Sometimes, good news is already priced into a stock. In this case, it clearly wasn’t. The reason why VNDA shares were so explosive today is because virtually no one expected Fanapt to get the green light.
There’s another big reason for paying more attention to the risk-reward ratio with biotech. And a profitable one, too…
Small-Cap Biotechs: 3 Benefits of Locking In Profits
I’m a big proponent of taking partial profits on a winning position when appropriate. If a small-cap biotech stock is up significantly, locking in some gains serves three purposes:
- Returns Investment Capital: While remaining in the position, I now have capital to put into other opportunities.
- Helps Weather The Downside: If I still believe in the company and the investment, taking partial profits allows me to give the stock more room to fluctuate, as I’m no longer concerned with losing my original investment.
- Participate In Upside: Having secured my original investment, I can now allow my winners to run. That’s where truly large gains happen.
Recently, when I recommended that subscribers take partial profits in a top-performing stock, I received a ton of email asking why… particularly when I expect the stock to go significantly higher.
I emphasized the reasons above - that taking some profits lowers our level of risk, while still allowing us to go for the home run.
I’ll give you another specific example…
In my small-cap healthcare service, Access, we took 65% gains in half our position in SIGA Technologies (Nasdaq: SIGA). That’s allowed us to let the stock run to current levels, which are now 158% above our entry price.
So while VNDA blasted its way higher today, remember that it’s a perfect example of how volatile the market can be - and how things don’t always happen the way you expect.
One of the best ways to make sure that volatility doesn’t negatively impact your portfolio is to play with the house’s money whenever possible.
Marc Lichtenfeld
P.S. For more information on how you can join my small-cap healthcare and biotech investment service - Access - simply check out this link.
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