Investors in Axonyx
As one of my colleagues noted earlier this week, Axonyx got a particularly nasty drubbing because it doesn't have much in the way of a pipeline to back up this drug. Thus, with a seeming failure on their hands, shareholders had little left to love about the company. He described an investment in Axonyx as "gambling, not investing" -- something that fails more often than it succeeds.
That's a fair enough description. Even when you're looking for aggressive growth stocks, you should seek out companies that offer more than a single toss at the dartboard. A biotech company can build a pretty decent empire out of a single product -- look at Icos Pharmaceuticals
All that being said, many biotech investors like to pepper a portfolio of well-diversified companies with a few chances to swing for the fences. Even those who eschew the riskiest of biotechs still feel the pain of product failure -- witness, for instance, Motley Fool Rule Breakers pick BioSante
Yet we all learned years ago from investment guru Kenny Rogers that the secret of success is knowing when to hold 'em and when to fold 'em. So what does history tell us about what investors in Axonyx should be doing right now?
Wait for the smoke to clear
It seems pretty clear to me that in most cases, investors will make more money if they simply ignore bad news. Even if you decide after calm, rational reflection that you want out of a stock, selling directly after the release of a clinical or regulatory setback is probably the wrong strategy.
Why? The reasons are as varied as the pitfalls that snare tiny biotechs, but a big part of it comes down to investor psychology. Biotech stocks trade not just on fundamentals but also on intangibles like hope, enthusiasm, fear, and panic. The day bad news is announced, fear and panic hold sway. More often than not, that panic sends stocks to extreme lows that don't hold. Or, put another way, the market has not yet digested any mitigating news that might make a seeming disaster not quite as bad as it first appeared. As a reason for hope emerges -- and there usually is one -- the stock tends to recover.
Consider a few examples of companies -- chosen pretty much at random -- that have suffered major failures in one or more clinical programs over the past several years. In every case, selling on the day that bad news was announced would have been one of the worst things you could have done.
Let's hop in the wayback machine and visit Alexion
You can find a similar example looking at Amylin Pharmaceuticals
For that matter, look at Dendreon. Or Pharmacyclics, Scios (now part of Johnson & Johnson), CV Therapeutics, Sepracor, ImClone, or any number of other companies that have faced product disasters.
Learning from La Jolla
But to really bring the point home, look no further than La Jolla Pharmaceuticals
Strike two came on Feb. 18, 2003, when a phase 3 study essentially confirmed what investors learned back in 1999. Shares had opened at $8.02 the day of the announcement; they next opened at $1.49. Should you have sold then? If you did, you missed a ride back up to $5 by that September.
Just this past Oct. 14, La Jolla whiffed again on its third time at bat. The company submitted Riquent for FDA approval on the basis that the drug improved some surrogate markers (lab measurements that give an indication of progress in treating a disease) in lupus. The FDA issued La Jolla an "approvable" letter, meaning Riquent could potentially be marketed if the company could just answer some outstanding questions. involving a new, multiyear clinical trial requiring millions of dollars that the company no longer had. This, surely, was the final straw. La Jolla had no other active programs, very little cash, no clear means of completing the study that the FDA requested, and an uncertain market even if it could. Was there any conceivable reason to hang on after this announcement? Well, La Jolla went as low as $1.05 the day following the announcement, yet it was back above $2 a month later and still trades today higher than it did directly after that announcement.
None of this is to say that a savvy investor could have somehow played these turns of fortune for profit. It would have taken incredible dumb luck to have found the right entry and exit points. La Jolla was pretty much an unmitigated disaster for its shareholders. But the one thing that holds true for it, just as with many other biotech companies, is that leaving the stock directly after a major piece of bad news proved to be about the worst exit point. The three dates above were among the only times in the past decade when you shouldn't have sold La Jolla.
Are there exceptions to this rule? I expect that alert readers will remind me of some in the coming days. But one interesting potential example facing investors right now is Adolor
Thus, it is probably more foolhardy than Foolish to actually load up on a biotech stock that has just been knocked down. After all, while I'm fairly confident that Axonyx will eventually trade at higher levels than it reached on Monday, that doesn't mean it might not subsequently get knocked back even further. Ultimately, you should be investing based on a fundamental belief in a company and its prospects. But the patterns I see among troubled biotech companies suggest two things: First, that long-term investors will, much more often than not, win out over the traders by buying and holding. (Plus, they get to hit the snooze alarm on ugly days.) Second, even when it comes time to sell, history shows that it is usually worth waiting for the smoke to clear after a disaster.
Karl Thiel does not own shares of any companies discussed above. He is almost always in favor of hitting the snooze. The Motley Fool has a disclosure policy .