We've taken a look in our last twoarticles at biotech companies that delivered fivefold returns over the past two years, in the hopes of identifying some universal characteristics -- some Rule Breaker DNA -- that will help us find the next batch of home-run hitters.
We have seen two mechanisms at work driving these stocks to monstrous gains in a short period of time. The first is the comeback of companies with quality drugs that have been temporarily beaten down for one reason or another. Picking up distressed companies the market hates can be a rewarding strategy if you can correctly identify which problems will be short-lived.
The second approach appeals to the speculators in the audience. In my last article, I presented two small companies -- Axonyx and Genaera -- that are working to fill unmet medical needs, working on diseases where treatment options are inadequate. Such situations present great opportunities for drug companies to launch superior products that capture high market share. Finding these drugs ahead of other investors is one path to market-trouncing returns.
Today's approach shares last week's highly speculative approach, but with a more specific focus. Year after year, the hottest biotech companies with investors are those with drugs in development for the treatment of cancer. Notable success stories include Genentech (NYSE: DNA ) with Avastin, Herceptin, and Rituxan; ImClone Systems (Nasdaq: IMCL ) with Erbitux; and Millennium Pharmaceuticals (Nasdaq: MLNM ) with Velcade.
These companies are at the leading edge of a paradigm shift in the treatment of cancer. Traditional chemotherapy drugs indiscriminately kill every dividing cell in the body, whether it is cancerous or a normal, healthy cell, leading to very nasty side effects. The new breed of cancer drug is designed to target only tumor cells, vastly reducing side effects and ideally working better.
These new cancer therapies will be very hot commodities for the foreseeable future. The two companies I'm highlighting today have these drugs in development and have advanced their programs to the point where the market is paying attention.
A timely acquisition
For several years, Keryx Biopharmaceuticals (Nasdaq: KERX ) has been developing KRX-101 (Sulodexide) for the treatment of diabetic nephropathy, a kidney disease that affects patients with diabetes. With the movement of this program into a phase 2/3 trial in late 2003, the stock began to recover from all-time lows.
While KRX-101 remains a clear and important value driver for Keryx, the acquisition of private biotech ACCESS Oncology in February really propelled the stock. The purchase brought in three early-stage cancer compounds, the most advanced of which is KRX-0401 (perifosine). Following this acquisition, the stock rose to a high near $20 before settling back down to the current range around $11. Investors who bought in when the stock was under $2 a share in late 2002 are probably pretty happy with the outcome.
KRX-0401 works by blocking the activation of an important enzyme called Akt. Once Akt is active, it is involved with the growth and survival of tumor cells, so keeping it inactive is potentially a good drug development strategy, possibly making it easier to halt the growth of tumor cells and kill them.
Right now KRX-0401 is in a number of phase 1 and phase 2 clinical trials. By the end of 2005, Keryx expects to have planned out which cancer types to pursue in phase 3 trials to get FDA approval.
From virus to small molecules
Onyx Pharmaceuticals (Nasdaq: ONXX ) used to be focused on using genetically engineered virii to target and kill tumor cells while not harming normal cells. This unproven technology was dealt a crushing setback on the lead drug, ONYX-015, in late 2001, after which the company shifted its efforts to the development of cancer compound BAY 43-9006, with partner Bayer (NYSE: BAY ) .
BAY 43-9006 is a small molecule drug that blocks an important pathway required for tumor cells to grow. The drug doesn't kill tumor cells; it just stops them from growing. Before an important cancer conference in November 2002 at which the companies reported early data, Onyx stock sold for about $4. After the conference, interest and price skyrocketed, reaching a high of $60 this year.
Of course, when stock prices are supported by investor sentiment, they can quickly move in the other direction, and that is what happened recently as the effectiveness of the drug has been called into question. Right now, shares are trading near $28, which is still a tremendous return for investors who took a chance on a phase 1 cancer drug when the company's stock was down.
Companies like Genentech, ImClone Systems, and Novartis (NYSE: NVS ) blazed the trail in new therapies for the treatment of cancer. The success of drugs like Avastin, Herceptin, Erbitux, and Gleevec has investors searching far and wide for the next winner.
As we see with Keryx and Onyx, small molecule therapies for the treatment of cancer remain highly sought-after commodities. Staggering increases in a company's market cap now come with any hint of efficacy as these drugs move through clinical trials. Investors do not need to wait until actual approval and sales to get a return on their investment.
This flies in the face of conventional wisdom that profits drive share price in the long run. In biotech land, it is the anticipation of future profits that causes the big moves. If you want to play this high-stakes game, you have to start early.
Early-stage cancer drugs that are either small molecules or monoclonal antibodies are the ones to watch because they are the proven technologies in cancer drug development. There is enough risk in investing in experimental drugs without having to worry about whether or not the technology even works.
However, it is not enough to find an early stage drug. As with any potential Rule Breaker, valuation is still crucial. Drugs early in development have a very high failure rate, so invest when the company is as cheap as possible. As a rule of thumb, I'm looking for companies with a market cap between $50 million and $150 million with the hope that success in clinical trials will boost the company over the $500 million mark. That tends to be the shift in valuation when a drug moves from unknown chemical compound to a therapy with proof of concept and some promise.
This is one of the strategies I use in Motley Fool Rule Breakers to find the next biotech 5-baggers, although the Rule Breaker team uses a wide range of techniques to find high-growth potential for your portfolio. If you'd like to see what David Gardner and his team of analysts have cooking, we invite you to take a risk-free free trial with no obligation.
Fool contributor Charly Travers owns shares of Keryx.The Motley Fool is investors writingfor investors.
For additional articles on the drug industry, see: