What happened

It's been a pretty good to year to be a development-stage biopharma company. Increasing appetites for risk sent shares of small cap biotechs Achillion Pharmaceuticals (NASDAQ:ACHN), Aurinia Pharmaceuticals (NASDAQ:AUPH), Cara Therapeutics (NASDAQ:CARA), and Galmed Pharmaceuticals (NASDAQ:GLMD) much higher than the S&P 500 through the first nine months of 2018. But a broad market sell-off in October caused each stock to fall at least 18.1% last month alone according to data provided by S&P Global Market Intelligence.

Company

Stock Performance, First Nine Months of 2018

Stock Performance, October 2018

Achillion Pharmaceuticals

27.8%

(22.3%)

Aurinia Pharmaceuticals

46.6%

(18.1%)

Cara Therapeutics

95.7%

(21.8%)

Galmed Pharmaceuticals

48.4%

(34.1%)

Source: S&P Global Market Intelligence

Each of these pre-commercial biopharmas has big plans for its pipeline and its future. Investors and Wall Street analysts obviously thought enough of them to send them soaring for most of the year. Does last month's market slide create any buying opportunities among these four small cap biotech stocks?

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Image source: Getty Images.

So what

There wasn't any company-specific news that pushed Achillion Pharmaceuticals lower in October, although the clinical-stage biopharma has recently replaced nearly its entire C-suite. The new team is hoping for a fresh start as the company focuses on developing a pipeline comprising five mid-stage trials under way and recruiting for its lead drug candidate, ACH-4471, which is being investigated as a potential treatment for a rare disease that affects kidney function. It has two next-generation drug candidates in the same class as ACH-4471 that may allow for less frequent dosing.

If that sounds like a narrow focus, then that's because it is. Achillion Pharmaceuticals is a shell of its former self, and has seen its market cap fall from $1.3 billion three years ago to just $415 million today. It's possible that the company can find success in its current niche, especially considering it had $283 million in cash and cash equivalents at the end of September, but the new management team has promised it will provide a strategic update on operations and future plans in mid-December. Investors should wait until then before getting carried away with this small cap biotech.

Aurinia Pharmaceuticals has created excitement around its experimental lupus treatment, voclosporin, throughout 2018. There's a large unmet clinical need for lupus, and some analysts think that the drug candidate could become a blockbuster drug with over $1 billion in annual sales if it delivers success in a phase 3 clinical trial that's now under way. In fact, the late-stage study finished enrolling patients at the end of September, and since the trial design calls for 52 weeks of observation, investors should get an answer on its market potential by the end of 2019.

Considering Aurinia Pharmaceuticals sports a current market valuation of under $500 million and the best-case scenario for voclosporin is pretty bullish, it wouldn't be surprising for the stock to rise (and become volatile) in the next 12 months as the date nears for the big data release. But investors that want to bet on a positive outcome in this binary time bomb should consider the high level of risk involved, too.

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Image source: Getty Images.

Cara Therapeutics had nearly doubled from the start of the year through the end of September. Investors are increasingly confident about the pre-commercial company's lead drug candidate, Korsuva, which is being developed as a potential treatment for chronic kidney disease-associated pruritis (CKD-aP). That's a mouthful, but it's the name of the condition for itching caused by dialysis treatment. And there's a sizable market opportunity with an estimated 270,000 patients in the U.S. alone.

Some analysts think Korsuva could see peak sales in excess of $500 million per year. But Cara Therapeutics very wisely looked to de-risk drug development by joining forces with Vifor Pharma Group, which owns 55% of a joint venture with Fresenius Medical Group, the world's largest dialysis services company. In other words, it's the perfect partner for Korsuva.

For its role in the partnership the small company netted $70 million in upfront cash and equity investments, is eligible to earn up to $470 million in milestone payments, and can earn royalties on top of that. That's helped push the market cap for Cara Therapeutics to $800 million today -- even though the company doesn't have another drug candidate in its pipeline. That makes this a very risky binary stock that most investors are better off avoiding at its current valuation.

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Image source: Getty Images.

And finally, Galmed Pharmaceuticals came out of nowhere earlier this year and threw down some impressive results for its lead drug candidate Aramchol, which is being investigated as a potential treatment for nonalcoholic steatohepatitis (NASH). While the drug could become a true underdog that finds success against the odds, investors shouldn't overlook a few things here.

First, the company sported a market cap of around $100 million before it reported surprising results for Aramchol in June. It's rare for tiny cap companies to develop blockbusters. Second, the company had to play around with the numbers a bit to show a dose-dependent response for the drug, which should raise some eyebrows. Third, at least part of the stock's rise is due to the association with NASH, which has been a red-hot corner of the drug industry recently. Therefore, this is an easy stock for most investors to pass up.

Now what

These four small cap biopharma stocks were on fire for most of 2018, but fell sharply in the broad stock market sell-off in October. However, investors would be better off avoiding Achillion Pharmaceuticals and Galmed Pharmaceuticals at this time due to a high level of uncertainty and some lingering questions about the near-term future for each.

Aurinia Pharmaceuticals could be a big winner thanks to a combination of its relatively small market cap and the huge market opportunity for a lupus treatment, but that requires a risky bet on a clinical trial that could go either way. Cara Therapeutics could successfully develop Korsuva, but an $800 million market cap may leave few gains on the table for investors in the next year. And since it only has one drug in the pipeline, it's a very risky stock to own.

Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.