I'm Rich! I'm Ruined! Overreaction Equals Opportunity

Sometimes investors' reactions puzzle me. Feeding off of just a single piece of information, shareholders can cause wild swings in share prices.

Sounds like opportunity knocking to me.

Take a look at how these two drugmakers have fared over the past week:

Company

Increase (Decrease) So Far This Month

Dendreon (Nasdaq: DNDN  )

56.7%

Amylin Pharmaceuticals (Nasdaq: AMLN  )

(20.5%)

Source: Yahoo! Finance.

They're both cash-burning drug developers, so based on their share price change, you'd think that Dendreon had released positive data and Amylin's drug had flopped. Nope, not even close.

Anticipation
Dendreon's rapid appreciation appears to be because the American Urological Association gave the company time on April 28 to present data at its annual meeting. The company had already said in January that the data from the final trial for its prostate cancer treatment, Provenge, would be available in April, so the timing shouldn't have surprised anyone.

Giving the company time to talk at the conference isn't an indication that the trial was successful. Drug companies are increasingly presenting negative results -- Eli Lilly (NYSE: LLY  ) and Schering-Plough (NYSE: SGP  ) both did it recently -- and it's unlikely that anyone at the association knows the results anyway. When Dendreon applied for the timeslot, the employees probably didn't know the results -- and may not even know now.

Investing in drug developers is about estimating the chance of clinical trial success or approval by the Food and Drug Administration and then making sure you're being rewarded accordingly for taking on that risk. As Dendreon increases in price, the potential reward from a positive result decreases, and there's no clear sign that the risk of failure has gone down.

I see that as a sign to sell -- or at least to trim your holdings. You'll miss out on a huge increase if the results are positive, but holding on for that potential looks like a big risk to me.

Shades of gray
Amylin's share price fall didn't have anything to do with its drug directly, and while recent news did add some risk to the potential for an FDA approval of its once-weekly Byetta, it seems like investors have overreacted.

Last Thursday, an FDA advisory panel deadlocked over whether thyroid cancer seen in rats and mice given Novo Nordisk's (NYSE: NVO  ) diabetes drug, liraglutide, was a reason to keep the drug off the market. Because liraglutide is in the same class of drugs as Byetta, investors are worried that the cancer issue could also delay approval of Byetta's once-weekly version, which Amylin and partner Eli Lilly will submit to the FDA for marketing approval shortly. Alkermes, which is due to receive royalties from the drug, has also been beaten up over the last few days.

The lack of a ringing endorsement from the panel of experts lowered the likelihood of approval of liraglutide, but the side-effect profile isn't identical for the two drugs, and the panel's vote doesn't hurt once-weekly Byetta as much as it does liraglutide. While thyroid cancer in liraglutide was seen in male and female rats and mice at levels equivalent to what a patient would take, thyroid tumors were seen only in female rats given once-weekly Byetta at doses corresponding to more than three times what a patient would take.

There is no doubt that the cancer data adds risk of a FDA delay for once-weekly Byetta, but I don't think it's as dramatic as investors have made it out to be. This drug has the potential to be a blockbuster if it makes it onto the market and investors will be rewarded handsomely from this level if it does.

Value or value trap
The secret to knowing whether the dramatic rise or fall in a stock is a signal to buy or sell is to understand the company in and out. Whether it's drugmakers, financial companies like Citigroup (NYSE: C  ) , or automakers like Ford (NYSE: F  ) , you can't make rash decisions on whether to buy in (or sell out) unless you're keenly aware of what the value should be.

Buy and hold isn't dead, and I'm not advocating for commission-churning day trading, but when the market gives you a blue-light special, make sure you jump on it.

The Motley Fool's Rule Breakers newsletter service is always on the hunt for hot drug stocks and other cutting-edge picks. Click here to see all of our latest discoveries with a free 30-day trial subscription.

Fool contributor Brian Orelli, Ph.D., loves high-growth companies, but he doesn't like to overpay for them. He doesn't own shares of any company mentioned in this article. Novo Nordisk is a Motley Fool Global Gains recommendation. Seeing the Fool's disclosure policy is cheap, just click here.


Read/Post Comments (12) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 08, 2009, at 3:36 PM, benchackson wrote:

    Great journalism. Definitely fair and balanced!

    I think you left out few other companies that may also have presented negative results. Please include a disclosure about your position in this stock in your next article.

    Great Job!

    As always, Fair and Balanced!

  • Report this Comment On April 08, 2009, at 3:42 PM, benchackson wrote:

    I meant to write "your friend's position" in this stock.

  • Report this Comment On April 08, 2009, at 4:03 PM, FrankMom wrote:

    Interesting article. You are correct that DNDN presenting doesn't really tell whether the results are good or bad - but it is somewhat unlikely that DNDN would want to present negative results at the conference. You left out the fact that FDA panel voted for safety and effectiveness when interim results were presented to the panel. Usually the FDA respects the opinion of their panel, but in the case of Provenge they went the opposite way of their panel's recommentation. Their are serious questions of conflict of interests on the part of FDA employees who fought the approval - all profit from competing methodologies (chemotherapy & radiation) to the Provenge immunotherapy. Provenge has virtually no side effects, unlike radiation and chemo.

    Your article is adequate but leaves out some important information. At this time I do own shares of DNDN.

  • Report this Comment On April 08, 2009, at 4:27 PM, RU4R3AL wrote:

    Well, Cramer once said, and I would just throw at you...Stocks don't lie..people do....One thing that I have learned, and I am sure you know it too, stocks market is way ahead of the curve when it comes to pricing a security...Trend is set for both DNDN and AMLN and you are cought on the other end of it...so admit it and move on....

  • Report this Comment On April 08, 2009, at 4:32 PM, nextcsco wrote:

    This stock is going higher because the drug works.The longer you are on it the longer you will live

  • Report this Comment On April 08, 2009, at 8:41 PM, scambaitor wrote:

    DNDN's implied volatility is twice its historical volatility suggesting options being bid up in anticipation of news, usually buyout or approval of drug. Option specialist only with so many options in why the unusually high demand is driving prices to such insane levels.

    This huge imbalance of call buying 2:1 over puts is a reliable indicator the next move is up.

    Bio techs are notorius for FDA and drug mfg insiders using options bought by third parties to play a sure bet all while coming under radar of SEC which honestly doesn't even pursue insider trading as of late.

    With implieds so huge I locked in $400 profit per 100 shares by selling May 10 calls and purchasing May 5 puts with stock at 6 entry price. All %100 risk free arbitrage.

  • Report this Comment On April 09, 2009, at 3:00 PM, bhessel wrote:

    OK, lemme get this straight...so buy a May $5 put (UKOQA) for $220 and sell a May $10 call (UKOQB) for $620 and buy 100 shrs of DNDN for $600...net investment $200...if the stock ends below $5, the call you sold is worthless and you use the put to sell the stock at $500, which leaves you up $300...if the stock finishes between $5 and $10, all the options expire worthless and you sell the stock for between $500 and $1000, with a profit between $300 and $800...if the stock finishes north of $10, your put is worthless and you have to deliver your 100 shares of DNDN for $10, which leaves you up $800.

    So, your ROI is minimally 50% and tops out at 300%...that sound right?

  • Report this Comment On April 09, 2009, at 3:03 PM, bhessel wrote:

    sorry, make that minimum ROI of 150%....

  • Report this Comment On April 09, 2009, at 3:04 PM, bhessel wrote:

    ...and max profit is $600, not $800...

  • Report this Comment On April 10, 2009, at 2:41 AM, Ranoff wrote:

    Sounds like somebody got caught holding some Amylin, on the long side. Maybe, even shorting some Dendreon? Ha, Ha, Ha! Amylin got screwed. Boo Hoo Hoo!

    We all make our share of mistakes, but there's no reason to drag everyone else down with your problems.

  • Report this Comment On April 13, 2009, at 12:57 AM, emilhessel wrote:

    Had the options confused on Friday...the correct securities are:

    DNDN closed at $6.30

    UKOEB ($10 May calls) closed at $1.53

    UKOQA ($5 May puts) closed at $2.20

    ...so this play may have worked at some point, but now with the calls priced less than the puts, the stock has to close on 15 May north of $6.96 to avoid a loss here. Your cost to implement this play at the Friday closing prices would be $6.97/share ($6.30 + $2.20 for the put - $1.53 for the call) so the downside is limited to $1.97/share - as owning the puts guarantees you a minimum of $5/share - but there is a downside.

  • Report this Comment On April 14, 2009, at 9:14 AM, RU4R3AL wrote:

    Told you, stocks/market don't lie..people do....see where it is today....

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