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Small cap biotechnology investing and trading is not for the faint of heart - witness Questcor's (QCOR) implosion today losing almost 50% of its market cap. Small cap biotechnology stocks are often heavily shorted for a variety of reasons. Some reasons for shorting may include stock offerings that dilute share value, critical binary events such as FDA decisions, clinical data releases, competitive drugs or treatments, or even the launch of new drugs such as Somaxon Pharmaceutical's (SOMX) Silenor or Avanir Pharmaceutical's (AVNR) Nuedexta that don't sell particularly well or underperform expectations. Not every stock that is heavily shorted is a dud or doomed to failure. In fact many times heavily shorted stocks can provide explosive capital gains given the right set of circumstances.

One strategy I have successfully employed multiple times, for large biotechnology stock gains, is searching for the following criteria:

  • Small cap ($300M - $2B)
  • Share price (less than $10)
  • High volume (average daily volume 1M or more)
  • Heavily shorted (float short over 15%)
  • Consensus analyst ratings of buy or better
  • Current share price less than analyst mean target price
  • Trending up (recently)

Using the above criteria, as a starting point, I have identified three stocks that I will put on my watch list and do further research(not in this article) to see if they are candidates for me to invest in or trade.

1) Exelixis Inc. (EXEL)

Sector Biotechnology
Market Cap $956.5M
Average Daily Volume 3.66M
Percentage Of Float Short 19.92%
Analyst Mean Target Price $6.21
Closing Price (9/19/12) $5.35
Recent Trend Up


(Click to enlarge)

Exelixis, Inc., a biotechnology company, engages in developing small molecule therapies for the treatment of cancer. Its focuses on developing cabozantinib product candidate that inhibits MET, VEGFR2, and RET proteins, which are key drivers of tumor growth, vascularization, and/or metastasis. The cabozantinib is in Phase III clinical trial for the treatment for medullary thyroid cancer.

My Analysis: Exelixis has a an FDA approval date for cabozantinib (for medullary thyroid cancer) coming up on November 29. The stock is starting to run up as that date approaches. Adding to the interest is the FDA cancelling a November 9th advisory panel for cabozantinib - leading many to believe approval is a done deal. I suspect EXEL will continue to run to the $7-$9 range prior to FDA approval date.

2) Intermune Inc. (ITMN)

Sector Biotechnology
Market Cap $623.9M
Average Daily Volume 1.14M
Percentage Of Float Short 19.41%
Analyst Mean Target Price $16.97
Closing Price (9/19/12) $9.49
Recent Trend Up


(Click to enlarge)

InterMune, Inc., a biotechnology company, engages in the research, development, and commercialization of therapies in pulmonology and orphan fibrotic diseases. The company focuses on therapies for the treatment of idiopathic pulmonary fibrosis, a progressive and fatal lung disease. It markets Pirfenidone, an orally active small molecule drug for the treatment of adults with mild to moderate IPF under the Esbriet name in the European Union.

My Analysis: Intermune announced on September 11 that France's Economic Committee has granted reimbursement for Esbriet for idiopathic pulmonary fibrosis at a cost of $32,000 per year. This is the first drug approved for reimbursment in France for this affliction. The drug will now be available to approximately 6000 - 8000 sufferers in France. The company is still working towards FDA approval and is currently in phase III testing with results expected in mid 2014. I think Intermune may run into the low to mid-teens as it continues to secure reimbursement throughout Europe however the big ticket will be securing FDA approval.

3) Sequenom Inc. (SQNM)

Sector Biotechnology
Market Cap $457.1M
Average Daily Volume 2.78M
Percentage Of Float Short 28.48%
Analyst Mean Target Price $6.38
Closing Price (9/19/12) $3.99
Recent Trend Up


(Click to enlarge)

Sequenom, Inc. provides products, services, diagnostic testing, applications, and genetic analysis products that translate the results of genomic science into solutions for biomedical research, translational research, molecular medicine applications, and agricultural and livestock research.

My Analysis: I love to see insider buying and over the past 2 months insiders have been purchasing SQNM shares. I have found insider buying is a fairly reliable predictor of future share price appreciation as is the case here. The company continues to work on getting insurers to reimburse for their tests and within the next year will be going to the FDA for approval of its MaterniT21 PLUS test. SQNM is definitely one to watch - with the high short interest at 28.48% of the float - any pieces of good news should continue to propel the stock upwards. I could easily see SQNM in the $6 - $10 range within the next six months.

Financial information and graphs sourced from FinViz, company description sourced from Yahoo Finance.

Source: 3 Sub $10 Heavily Shorted High Volume Small Cap Biotechs Rated Buy With Momentum