Which High-Flying Stocks Should Investors Avoid?

Our contributors give their take.

Jul 26, 2014 at 2:37PM

With the year a little over half finished, it seemed appropriate to take a look at the highest-flying biotechs and consider which might be best to avoid. We asked our top contributors for their take.

Todd Campbell: Saying that GW Pharma (NASDAQ: GWPH) has been on a run this year is a big-time understatement. Thanks to excitement surrounding its marijuana-derived biotechnology pipeline, GW Pharma's shares have more than doubled since the end of 2013. While the company has an intriguing product line up, including one drug already on the market, the surge to sky-high valuation reminds me more of a bubble than a bargain.

That's because its currently marketed product, Sativex, posted sales of just $13 million in the first quarter, giving it a $50 million annualized run rate that does little to justify a market cap north of $1.5 billion.

And while investors may be excited about a potential U.S. approval in cancer pain and in childhood epilepsy, the market opportunity in those indications seems limited given that Sativex would be relegated to second tier status behind commonly used opioids in cancer pain and the patient population for the type of epilepsy Epidiolex would treat is tiny.

There may already be signs of cracks in shares armor. After jumping more than 50% in June, shares have slipped by almost 20% so far this month. For my money, a perfect-world market value and roller coaster volatility make this stock very risky.

Brian Orelli: While it's pulled back considerably from its post-approval highs, I'm still going to call out MannKind (NASDAQ: MNKD) here, trading up more than 70% year to date.

This isn't to say that MannKind's inhaled insulin Afrezza, doesn't have potential. It does.

But the risk-reward doesn't look particularly good to me at a market cap of $3.5 billion, which is actually considerably higher if you add in all the outstanding warrants and options.

Predicting MannKind's short-term movement is impossible, but long-term it'll ultimately be valued on sales of Afrezza. At a price to sales ratio of five, there's already over $600 million in annual sales priced in. The ratio could expand before hitting a $600 million run rate, pushing up the valuation, but only if the launch is successful.

The risk -- that I don't think is fully appreciated in the current valuation -- is that doctors take a wait-and-see attitude with Afrezza. They prescribe it to a few patients, perhaps someone with fear of needles, but avoid giving it to a wider population because of the new mode of action. With concerns over impairments to lung function and lung cancer, doctors may not want to expose a large number of patients to Afrezza until they have real-life experience with it.

If that situation comes to fruition, like we've seen with the obesity drugs, MannKind's value could drop precipitously.

George Budwell: Shares of Achillion Pharmaceuticals (NASDAQ: ACHN) have bolted higher this quarter by an eye-popping 150%. Achillion's slingshot move higher has been propelled by the acquisition of fellow hepatitis C drugmaker Idenix by Merck for a reported $3.85 billion, the unexpected release of a clinical hold for its hepatitis C clinical candidate sovaprevir, as well as a positive note from Wells Fargo that its early stage study for ACHN-3422 is going well so far. All told, Achillion is riding a wave of good news this quarter, but the stock now looks grossly overvalued, in my opinion.

While investors appear to be betting that Achillion will be bought out at some point for a hefty premium, I have a hard time believing this scenario will come to pass. First off, Merck's acquisition of Idenix probably wasn't the best idea, given that the hepatitis C market is predicted to drop significantly in Western countries that can afford expensive new therapies. As such, Gilead and Johnson & Johnson look like they will benefit greatly from having first-mover advantage in this market. And AbbVie's therapy for genotype 1 patients will be yet another roadblock for new drugs hoping to gain market share. In short, I think Achillion is simply too far behind its competitors and offers little value going forward as a result. 

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George Budwell, Todd Campbell, and Brian Orelli have no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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