Biotech's 5-Baggers: Part 2

In last week's column, I wrote about three biotech companies that were knocked down and beaten up, only to come roaring back with winning drugs. But investing in distressed companies isn't for everyone, so fortunately finding biotech companies that are temporarily on the ropes is not the only way to attain returns that trounce the market.

An approach we use all the time in Motley Fool Rule Breakers is to find the good companies before the rest of the crowd. By leading the charge, those investors that find the best companies first get the biggest rewards. With the abundance of medical breakthroughs in the biotech industry, those of us with the Rule Breaker mindset have ample opportunities to invest ahead of the curve.

Today's article, and the article that will show up in this space next week, are about companies that have already captured the market's attention. These companies have delivered exciting, but preliminary, results that have the market thinking that these companies are onto something big, sending these stocks soaring. As these examples will demonstrate, being early to the party as a biotech investor can be a very rewarding experience.

Putting the brakes on Alzheimer's
Alzheimer's disease is a scourge upon the elderly, and it is one of the worst problems in health care with nearly 4.5 million cases in the U.S., according to the Alzheimer's Association. For now, there is no cure for a disease that is devastating to both patients and their families. However, biotech investors tend to be an optimistic bunch and believe that advances in care are on the horizon. Therefore, any company that has a drug in development that looks like it can slow down the advance of this disease is going to attract a lot of attention.

One small biotech that has captured the market's imagination because of work in this arena is Axonyx (Nasdaq: AXYX  ) , a company whose stock is up more than 500% in the past two years. The catalyst for this surge is a drug called Phenserine, which is being developed for the treatment of mild to moderate Alzheimer's disease.

Why is the market so excited about this drug? In a small phase 2 trial, phenserine showed a statistically significant benefit over placebo in a few measures of memory and cognition. That result gives a very preliminary hint that this drug works, and the market jumped all over that. Then, in mid-2003, Axonyx initiated a phase 2b and a phase 3 trial to gather additional information on how well the drug works and its side effect profile. Since the commencement of those trials, the stock went on quite a run because these trials bring the drug ever closer to approval.

Judgment day is almost here, with data from both of these trials expected in the first quarter of 2005. To say that this event is important for the company would be an understatement. If the results are good, Axonyx will continue its rise to prominence. Given the need for new drugs in Alzheimer's disease, that's the outcome everyone is hoping for. On the other hand, if the results are bad, then yell "Timber!" as the stock would very likely come crashing down.

Sharks don't get cancer
That's a pretty common belief, even though there is a lack of evidence to back it up. While Genaera's (Nasdaq: GENR  ) drug Squalamine, which was originally discovered in the tissues of the dogfish shark, is in clinical trials for cancer, it has really captured the market's attention in the treatment of age-related macular degeneration (AMD).

Data from a phase I/II clinical trial was released in mid-2003, and this trial showed that at a four-month follow-up, 100% of patients had preserved vision with 26% showing an improvement. That's an encouraging result in patients rapidly losing their eyesight. Since that time, the company's stock has rocketed over 500%. Not too bad of a return for an 18-month timeframe.

AMD is a disease that doesn't get a lot of media attention despite being the leading cause of blindness in people over the age of 50. This disease affects more people than you may think, with more than 200,000 new cases in the U.S. and 500,000 new cases worldwide each year. Unfortunately, the incidence is only going to increase along with the aging population.

The increasing number of AMD cases has made this a hot market for drug developers. The market leader is Visudyne, from QLT (Nasdaq: QLTI  ) and Novartis (NYSE: NVS  ) , which will have sales well over $400 million this year. On the verge of launching in this market, and ahead of Squalamine in development, are Macugen from Eyetech (Nasdaq: EYET  ) and Pfizer (NYSE: PFE  ) , and Lucentis from Genentech (NYSE: DNA  ) .

Genaera is conducting a series of phase 2 clinical trials and the phase 3 program is expected to start in the first half of next year. The data from these trials, along with the signing of a marketing partnership with big pharma, will determine if Genaera's stock continues on its torrid rise.

Concluding thoughts
What these two examples boil down to is that small biotech companies that have very few products in development pass through inflection points. An inflection point can be thought of as a company-changing event, after which the company will be in either far better or worse shape than the day before.

For small biotechs, this is nearly always the release of data from a clinical trial. Successful completion of a clinical trial provides more information about a drug and increases the odds that the drug will eventually be approved. That is one reason that these stocks shoot up after good news is released.

If the goal for an investor is to aim for one of these five-baggers, then one option is to invest before the company passes through the inflection point. Investors who took this approach with Axonyx and Genaera have done quite well. However, I absolutely have to point out that this is a high-risk strategy, and I do not by any means advocate indiscriminately buying small drug companies without careful consideration of the risks and rewards.

In next week's column I will present two more biotech companies that have delivered encouraging clinical trial data to the great joy of shareholders. These companies are operating in the hottest segment of biotech, the development of cancer drugs. And check out Motley Fool Rule Breakers for more companies -- in biotech and elsewhere -- that have the DNA investors want.

Read other Fool biotech commentaries:

Fool contributor andRule Breakersanalyst Charly Travers does not own shares of any company mentioned in this article. The Fool has adisclosure policy.


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