Our tweet of the week comes from Luke Timmerman, quoting Oleg Nodelman, founder and managing director of EcoR1 Capital, a value-oriented health-care investment fund. During a panel at Allicense, Nodelman commented that you can invest in a moldy piece of pizza if it's biologically active and has a 10% chance of working; it's just a question of valuation.
While investing in something that is likely to fail may seem counterintuitive, it's OK to make the investment as long as the potential upside justifies the risk. If a clinical trial only has a 1-in-10 chance of success, but the company will be valued 20 times higher if the trial is successful, that's actually a good investment. Investors just have to adjust the size of their investment appropriately, because there's a good chance the investment could be worthless after the binary event.
In the current market, with everything valued so high relative to where it was a year ago, it's hard to find these kinds of opportunities. But historically you can find examples like Aeterna Zentaris and Keryx Biopharmaceuticals (NASDAQ:KERX) that had a colorectal cancer drug, perifosine, in a phase 3 trial based on a subset of the phase 2 data. The chances for success were unknown, but both companies were priced low enough that they seemed worthy of an investment.
As senior biotech specialist Brian Orelli and health-care analyst David Williamson discuss in the following video, the best investors were able to buy the companies' moldy pizza when it was cheap and then sell it after the shares appreciated before the data was released.
Another example, MannKind (NASDAQ:MNKD), was obviously a good investment when it was left for dead under $2 a couple of years ago. Even if investors missed selling at the highs last August after the latest phase 3 data was released, they're still sitting on a 300% or more gain over just two years.
Based on his "don't lose money" rule, Warren Buffett would hate this strategy
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Brian Orelli, David Williamson, and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.