Biotech stocks that crater on negative clinical results or unfavorable regulatory developments can sometimes represent outstanding investing opportunities. Not all beaten-down biotech stocks, though, are diamonds in the rough. 

Among the 15 biotech companies that saw their shares slide by more than 10% last month, for instance, I'd personally only consider buying shares of three: Intercept Pharmaceuticals (NASDAQ:ICPT), Exelixis (NASDAQ:EXEL), and Sage Therapeutics (NASDAQ:SAGE). Here's why. 

Man making a dramatic face after pretending to be punched.

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Buy the fear

Intercept's value got chopped in half last month after the U.S. Food and Drug Administration issued a warning letter stating that incorrect dosing regimens of the company's primary biliary cholangitis (PBC) medicine, Ocaliva, have the potential to increase the risk of liver injury and death. The market appears to be bracing itself for the imposition of a black-box warning label that could restrict Ocaliva's use in some patients.

On a related note, there is a growing concern that this safety issue may also end up impacting the drug's potential use in nonalcoholic steatohepatitis -- an indication for which studies are underway. The previous expectation was that Ocaliva would be approved for NASH, and that indication is expected to generate the bulk of its peak sales down the road.

While the FDA's most restrictive label might sound like seriously bad news, Intercept's liver disease drug shouldn't be particularly impacted by it. If the FDA issues the black-box warning, most analysts -- as well as the company -- believe it will only serve to remind doctors to prescribe appropriate doses to patients with moderate and severe liver impairment. In that case, Ocaliva's sales shouldn't drop off in a meaningful way, and its broader clinical program should go on as planned without any major modifications.  

Value is in the eye of the beholder

Exelixis, a cancer drugmaker, saw its shares take a sizable step backward last month after analysts at Leerink Partners downgraded the stock in light of its ginormous price to sales ratio (P/S) of 22.3. Most biotechs trade at a far lower P/S of around 4.

Adding fuel to the fire, some of the company's management team also decided to sell shares last month, which may have reinforced the notion that Exelixis' blistering 1,300% appreciation in the past three years had left it somewhat overvalued. 

A deeper dive, however, suggests that Exelixis probably isn't overpriced relative to its longer-term growth prospects. Both of the company's main value drivers -- Cabometyx/Cometriq and Cotellic -- are in the early stages of their commercial launches, after all. And revenue from these drugs is expected to climb by a healthy 45.9% in just the next year.  

Exelixis' rapidly growing revenue stream and positive free cash flows  open the door to other value creating activities that arguably aren't currently reflected in its share price. The biotech's management, for instance, recently mentioned that they are exploring potential licensing deals to augment their existing pipeline, and are also in the process of restarting their own drug discovery platform. 

All in all, Exelixis' stock certainly isn't cheap after its monstrous move northward, but the premium may be worth it for a company that could eventually become a key player in the $100 billion-plus cancer drug market. 

Down but not out

Shares of clinical-stage biotech Sage Therapeutics took it on the chin last month after the company reported disappointing late-stage results for its experimental super-refractory status epilepticus (SRSE) treatment, brexanolone (SAGE-547). Brexanolone is the biotech's most advanced clinical candidate, and it was forecast to generate upwards of $100 million in sales next year if approved for this rare but life-threatening seizure disorder.

The good news is that brexanolone is close to the finish line for its other late-stage indication -- postpartum depression. According to the company's comments following the drug's miss in SRSE, brexanolone's two ongoing postpartum depression trials have been enrolling well, and are on track to readout in the back half of this year.

Most importantly, though, the pathology of SRSE and postpartum depression are entirely different -- meaning that the drug's failure in one shouldn't have any bearing on its ability to hit the mark in the other. So, with about $650 million in peak sales on the line for postpartum depression, Sage's stock definitely has the potential to come roaring back before year's end. 

Are any of these stocks worth buying right now?

Personally, I think Intercept and Exelixis are both solid long-term buy and holds, especially after their double-digit pullbacks in September. Intercept currently has the most advanced nonalcoholic steatohepatitis drug candidate in the game with Ocaliva, which may one day translate into $6 billion to $7 billion in peak annual sales. Exelixis, for its part, is now a multidrug cancer company, which gives it the financial firepower  to build a more robust clinical pipeline that could create long-term value for its shareholders. 

Sage, on the other hand, arguably has both the highest near-term upside potential and the steepest risk profile. If brexanolone redeems itself in postpartum depression later this year, the stock should skyrocket. But the converse is also true -- Sage's stock would almost certainly crater if its lead drug candidate fails yet again. As a more conservative investor, I tend to avoid betting on these kinds of binary events and the dramatic price swings that result from them. But this stock might be appealing for investors who are more comfortable with high levels of volatility and are on the hunt for unusual growth opportunities.  

 

George Budwell has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Exelixis. The Motley Fool has a disclosure policy.