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I don't like to invest in the biotechnology sector unless I see potential for major upside and limited downside risk. For example, when beaten-down shares of Chelsea Therapeutics were trading for just around $1 several months ago, I wrote an article suggesting it had limited downside risk and "huge reward potential," it now trades for over $3 per share.

In another article, I suggested that investors should buy Catalyst Pharmaceuticals (CPRX) in April 2013, when it was depressed and trading for just around 45 cents, it now trades for about $2 per share. In that same article I said Acadia Pharmaceuticals, Inc. (ACAD) was a buy when it was trading around $12, and now it is over $20.

These examples show how quickly investor sentiment can change and that can lead to huge percentage gains for savvy investors. One of the best strategies I have found is to buy stocks in this sector after a setback causes an exaggerated plunge in the share price. That was the strategy that worked so well in stocks like Chelsea Therapeutics and Catalyst Pharmaceuticals. Recently another setback and stock plunge occurred which appears to be a significant buying opportunity for investors seeking either short-term gains from what could be a near-term rebound, or even bigger gains from the long-term potential it holds:

GTx, Inc. (GTXI) shares were trading for about $7 in July, but the stock recently plunged after this biotech firm announced disappointing Phase III results for "Enobosarm" which was being developed to treat muscle wasting in cancer patients. Just take a look at the huge decline in the share price below along with a number of reasons why this could be a significant buying opportunity:


(Click to enlarge)

As the chart shows, this stock was up to about $7 in July in anticipation of positive results for Enobosarm. It appears that investors became a little too optimistic when bidding up the shares to that level but it also now seems like investors are being overly bearish by selling the shares for just around $1.40. Biotech stocks can be very volatile and highly susceptible to investor sentiment. Therefore, it can be extremely rewarding to buy when investors have "given up" on a stock, which leads to emotion-based selling. However, this type of buying strategy only makes sense when there are sound fundamental reasons as to why a biotech company can still move on from setbacks and eventually become a successful player in the industry. There are a number of indicators that suggest this stock is very undervalued now and possibly due for a sharp rebound:

1. One insider has made repeated and significant buys of this stock in the past few days. This insider buying appears to be driven by the desire to take advantage of the sharp decline in the share price, which is otherwise known as "bargain-hunting." On August 20, 2013, Jack W. Schuler (a beneficial owner of 10% or more of this company) purchased 110,005 shares at $1.45 each in a transaction valued at $159,518. On August 21, 2013, he purchased 199,586 shares at $1.40 each in a transaction valued at $278,961. Then on August 22, 2013, he bought another 93,777 shares at $1.36 each in a deal valued at $127,565. This is a total of roughly $640,000 worth of new insider buying in just a few days.

What makes this even more significant is that Mr. Schuler already had a significant stake in the company and now owns more than 7 million shares. In addition, it is worth noting that Mr. Schuler appears to be a savvy investor in this industry and he serves on the board of other biotechnology firms and has many millions of dollars invested in this sector. Mr. Schuler has extensive experience in this industry. He served as the President and Chief Operating Officer of Abbott Laboratories' (ABT) healthcare products, from January 1987 to August 1989 and he has over 30 years of experience in the pharmaceutical industry. The fact that Mr. Schuler is making significant new buys at this time seems to indicate that he believes the stock is very undervalued and that he remains confident in this company and its pipeline.

2. Investing in biotechnology can be a high risk and high reward proposition. This sector is full of stocks that have seen incredible gains, huge declines and even many stocks that have once again surged after pipeline setbacks. One way to minimize risks is to make sure the company has a strong balance sheet so that it can continue to operate and develop its pipeline. This company has a strong balance sheet with about $31.64 million in cash and no debt. This is equivalent to about 50 cents per share in cash. This financial strength reduces downside risks and it gives the company time to continue developing the pipeline.

3. Another way to reduce risks is to invest in companies that have multiple candidates in the pipeline and fortunately, GTx has two candidates in development, Enobosarm and Capesaris. Even though Enobosarm results did not meet the pre-specified responder analyses, the company stated:

"...we are encouraged by the unambiguous effect of enobosarm on muscle and we are confident that it will translate to clinical benefit and potentially increase survival in patients with non-small cell lung cancer," said Mitchell Steiner, M.D., CEO of GTx. "We look forward to sharing our clinical data from these and previous trials with FDA and European authorities to discuss the path forward."

While it might be off the front burner for some investors now, the company clearly still sees potential in Enobosarm. Investors are likely to take a wait and see attitude on Enobosarm for now, so the focus is likely to shift to "Capesaris" which is being developed as a selective estrogen receptor alpha agonist, for the treatment of men with advanced prostate cancer. Capesaris is in Phase II development, which means that it might not be long before investors consider the upside potential for this pipeline candidate, and that is another reason, why the stock could have significant rebound potential.

Capesaris has already achieved some initially promising clinical results although at high doses and for long-term usage there could be safety concerns. Because of this, the company is testing in Phase II with different dosage levels. The goal of this clinical trial is to conduct an initial test of the activity and safety at three different dose levels in men at 125, 250, and 500 mg daily. According to BCC Research, (see graph below), the global prostate cancer market is estimated to reach about $50 billion by 2017. Drug therapeutics for prostate cancer is expected to be worth about $18 billion. This gives a sense as to the potential blockbuster status some prostate cancer treatments will reach and that is another reason why GTx remains a high-potential stock.


(Click to enlarge)

4. This stock is now extremely oversold and there is also a short squeeze potential developing. As the chart above shows, the relative strength index or "RSI" for this stock is just 16. When the RSI level reaches 30 or lower, stocks are generally considered to be oversold. When oversold conditions are reached, there is the potential for a significant rebound, which is often based on the thought that the level of selling has reached extreme levels based on emotion and momentum that cannot last much longer. With GTx shares having an RSI level of only 16, it is extremely oversold and this does appear to make a sharp rebound more likely.

Furthermore, a significant rebound might be fueled by shorts. We have to remember that this stock was trading around $7 per share just weeks ago, and now it is just over a buck. Shorts have made a fortune in just a matter of weeks and because this stock has begun to form a base between around $1.30 to $1.50 per share in recent days, shorts should be now seeing that this stock appears to have bottomed out.

According to Shortsqueeze.com, there are nearly 6 million shares short, this represents about 30% of the float. Based on average daily trading volume of 700,000 shares, the short interest represents about 9 days worth of trading volume. With so many shorts having made so much money here in recent weeks, many will presumably want to lock in those gains soon, especially if they see the stock has stabilized and that it could be poised for a rebound which oversold stocks often see.

The combination of the fact that this stock is extremely oversold and now has stabilized, coupled with a strong balance sheet, significant insider buying, and with Capesaris in Phase II development, bargain hunters and shorts are likely to fuel a strong rebound rally in this stock soon. From current levels, even a partial rebound could create significant percentage gains. Considering that the stock was trading at $7 just weeks ago, and with about 6 million shares short, it would not be surprising for this stock to trade back over $2 per share in the coming days. That would offer investors potentially quick gains of about 40% or more.

Stocks that have seen a big share price decline often experience three stages after a plunge: 1) Capitulation, 2) Stabilization, and 3) The Rebound. When looking at the recent trading in this stock, it is easy to see that capitulation has occurred based on the volume and price action. It is also easy to see that the stock has stabilized which is the second step before a potential rebound occurs. When you see below that over 17 million shares traded on August 19, this was the capitulation day. When you also see that trading volumes are rapidly "normalizing" to more reasonable levels, and that the stock has been trading in a range of about $1.31 to $1.51 for several days, the shares have clearly stabilized. The next phase to come appears to be the rebound, which looks likely to be fueled by bargain hunters (like the buying being done by Jack Schuler) and by shorts who are likely to want to lock in profits before a potential rebound occurs.

  • Volume on Aug 28, 2013: 1,117,600 shares, closing price $1.35
  • Volume on Aug 27, 2013: 1,051,900 shares, closing price $1.37
  • Volume on Aug 26, 2013: 1,318,000 shares, closing price $1.43
  • Volume on Aug 23, 2013: 1,766,800 shares, closing price $1.45
  • Volume on Aug 22, 2013: 1,078,900 shares, closing price $1.38
  • Volume on Aug 21, 2013: 2,506,800 shares, closing price $1.44
  • Volume on Aug 20, 2013: 3,579,400 shares, closing price $1.49
  • Volume on Aug 19, 2013: 7,120,800 shares, closing price $1.43

Clearly, like with any biotechnology investment there are potential risks that remain and this company could be facing significant challenges if Enobosarm continues to disappoint or if Capesaris does not achieve positive results. That could force the company to sell its pipeline and remaining assets at prices that could cause losses for shareholders. However, those issues might not occur and are too far on the horizon to be a risk now anyway. Furthermore, if the company gets back on track with Enobosarm or announces positive results for Capesaris, this stock could be back at $7 per share, which is the price target analysts at Stifel gave it earlier this year. With just over a buck in downside potential in a worst-case scenario, and potentially $7 per share or more if things go well, that is the type of risk to reward ratio that makes sense to me. However, in the short term, the upside potential is probably limited to somewhere in the $2 to $3 range.

Data is sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.

Source: GTx: 4 Reasons Why This $1 Biotech Stock Could Be Poised For A Big Rebound