Small-Cap Biotechs: How to Separate the Contenders from the Pretenders

By Marc Lichtenfeld

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% Thursday 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 altogether - 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.

Disclosure: No positions

Comments

[baltbear:]

what you are calling "Locking In Profits " i would term "trade into accumulation." if the "story" makes sense, then risk/reward profile can be maxed by recovering risk capital while leaving shares in inventory.
i would add a 4th benefit: that risk capital can be ploughed back in and out on trading ops, helping to support the ticker's access to capital markets, and letting the original due diligence get recycled as a tool for reading the tape.

May 08 04:01 PM

[jimmy Turano:]

Marc your story is true with your reasons and doubts and including those who were in 3 years ago at $25.00. This same story could in fact apply to 'mrna' formerely nastech. After 25 years of potential nasal delivery, they abandon that and now have rnai technology platform. This stock to was $20 dollars over two years ago, & many shareholders have been decimated. Now at $.97 cents, facing de-listing, letter of going concern, shareholders are to stike it rich. Forget about 'MRNA' FUNDAMENTALS& STAISTICS, THEY ARE JUST LOOKING TO PARTNER& PAY DOWN THEIR HUGE BURN RATE. BUT I DON'T SEE POTENTIAL SUCCESS IF ANY FOR 5-8 YEARS DOWN THE ROAD. WHAT DO YOU THINK?

May 09 09:19 AM

[jimmy Turano:]

Marc your story is true with your reasons and doubts and including those who were in 3 years ago at $25.00. This same story could in fact apply to 'mrna' formerely nastech. After 25 years of potential nasal delivery, they abandon that and now have rnai technology platform. This stock too was $20 dollars over two years ago, & many shareholders have been decimated. Now at $.97 cents, facing de-listing, letter of going concern, shareholders are trying to stike it rich. Forget about 'MRNA' FUNDAMENTALS& STATISTICS, THEY ARE JUST LOOKING TO PARTNER& PAY DOWN THEIR HUGE BURN RATE. BUT I DON'T SEE POTENTIAL SUCCESS IF ANY, FOR 5-8 YEARS DOWN THE ROAD.
WHAT DO YOU THINK?
SPIN THE WHEEL, WASTE OF TIME, WASTE OF MONEY, OR IT IS WHAT IT IS AFTER 26 YEARS, A BROKEN DOWN COMPANY BUT WITH A NEW NAME AND NEW CEO WITH ALWAYS THE KEY WORD 'POTENTIAL' LIKE THE FIRST 25 YEARS.

May 09 09:26 AM

[Alan Young:]

This is a good story, but fails to answer the problem posed by the headline. Of course, look for a good risk/reward ratio--but how? It would be nice if there were some kind of formula.

May 10 01:52 PM