It's not uncommon for inexperienced investors to go through a penny stock phase. The rationale is understandable: You can own hundreds or thousands of shares of a company that trades for a few cents a pop. 

It seems like a great deal, especially in the dreamy scenario where the stock appreciates. The problem is that many penny stocks trade in that low range for good reasons. The businesses usually aren't legitimate, have glaring red flags, and are probably too small to be publicly traded in the first place. To be blunt, penny stocks usually go bust, not boom. 

That doesn't mean investors have to shun all high-risk stocks as they gain experience. In fact, it can be exciting to own under-the-radar stocks with the potential to pop -- so long as risky stakes are balanced out responsibly. If that sounds appealing to you, then consider taking a closer look at Mesoblast (NASDAQ:MESO) and Selecta Biosciences (NASDAQ:SELB).

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A promising COVID-19 treatment, but that's not all

Investors would be forgiven for avoiding stem cell stocks such as Mesoblast. Despite decades of technological hype, the field of stem cell research hasn't generated many commercial success stories. But that might be too broad of a condemnation. After all, there are a half dozen different types of stem cells, several ways to harvest or grow them, and new advances in genetic engineering that could make next-generation treatments safer, more effective, and easier to manufacture. 

Mesoblast might be the most promising stem cell company accessible to individual investors. Earlier this year, the Australian biopharma submitted a biologics license application (BLA) to the U.S. Food and Drug Administration (FDA) for remestemcel-L in pediatric steroid-refractory acute graft-versus-host disease (GVHD). Regulators will decide on the application by Sept. 30, which means the company could transition to commercial operations before the end of 2020.

The product, which will be branded as Ryoncil in the U.S., has been sold under the Temcell brand in Japan since 2016. In the trailing-12-month (TTM) period ending March 31, Mesoblast received $7.6 million in royalty payments from the Japanese sales of its partner, JCR Pharmaceuticals. The U.S. market for GVHD is eight times larger than that of Japan -- and the biopharma owns 100% of the rights.

Investors have two major events on the calendar before the FDA rules on Ryoncil in September. First, a phase 3 clinical trial evaluating rexlemestrocel-L in advanced heart failure is expected to report top-line results in mid-2020 -- likely any day now. Most studies of stem cells in inflammatory ailments such as heart disease and stroke have disappointed to date, so investors might want to keep their expectations in check.

Second, a phase 2/3 clinical trial of remestemcel-L in COVID-19-associated acute respiratory distress syndrome (ARDS) is expected to have results this summer. The product candidate is being administered to individuals who require mechanical ventilation to survive. While investors are hopeful that encouraging results from a 12-patient study completed in April will be replicated in the ongoing 300-patient study, the quickly evolving landscape of COVID-19 treatment could affect the product's market potential. 

Many doctors are now hesitant to place COVID-19 patients on ventilators, as the practice significantly increases the lethality of the disease. Fewer patients on ventilators mean fewer patients for the designed use of remestemcel-L (although it's good news from a public health standpoint).  However, it's possible for Mesoblast to study the drug candidate's use in severe cases of COVID-19 that don't require mechanical ventilator support, which could significantly increase the patient population for the treatment. First things first, of course: The company needs to deliver positive results before investors get too carried away.

Long story short, Mesoblast is a high-risk, high-reward cellular medicine developer. The Australian biopharma is widely expected to earn approval for Ryoncil in pediatric steroid-refractory GVHD in the United States in 2020, which would significantly improve its financial stability. And if rexlemestrocel-L is effective in treating advanced heart failure or remestemcel-L shows promise in severe COVID-19, then the company could earn a market valuation well above its current $1.5 billion level.

A businessman aiming a martial arts kick at a wall painting of microbial cells.

Image source: Getty Images.

A huge pivot that might just pay off

In mid-June, Selecta Biosciences made a bold move that displeased Wall Street and confused many investors. The company sold the rights to its lone clinical-stage asset -- SEL-212, which treats chronic refractory gout -- to Swedish biopharma Sobi. The asset is set to begin a phase 3 study in the second half of 2020 and, if successful, could target a $1 billion per year market opportunity that's largely untapped.

Although the small-cap stock fell on the news that Selecta Biosciences would haul in "only" $100 million in total upfront payments from the licensing deal with Sobi, the transaction could prove brilliant in the long run. Management monetized an asset that isn't guaranteed to earn regulatory approval or become a commercial success and pivoted the business's focus to a more lucrative opportunity: becoming a must-have partner for biologic drug developers. 

Selecta Biosciences has developed a technology platform built on the concept of immune tolerance, called ImmTOR. When the adaptive immune system is exposed to an antigen -- a foreign substance such as a virus or pollen particle -- it's programmed to develop neutralizing antibodies so the body retains a memory of past encounters with external invaders. That works evolutionary wonders when the antigen is a virus or harmful substance; triggering the creation of neutralizing antibodies is the key focus of coronavirus vaccine candidates, for example. Yet it becomes an expensive obstacle when the antigen is a monoclonal antibody, cell therapy, or gene therapy. In these latter scenarios, it can make biologic drugs less effective, or even harmful, after their first dose. 

The ImmTOR platform leverages existing immune system regulatory pathways to avoid the creation of neutralizing antibodies. The idea is that ImmTOR could make biologic drugs safer and more effective. For example, an adeno-associated virus (AAV) vector-based gene therapy can usually only be dosed once, but applying the concept of immune tolerance could allow gene therapies to be dosed as many times as necessary to drive curative results. 

Admittedly, investors have to take a leap of faith with the pivot, as there aren't clinical-stage results to pore over. But Selecta Biosciences has already inked collaborations with AskBio, Sarepta Therapeutics, and Spark Therapeutics -- among the leading gene therapy developers -- for the ImmTOR platform. There's potential to expand into monoclonal antibodies, enzymes, and cell therapies, too. At a market cap of roughly $250 million and with the first ImmTOR clinical trial in gene therapy to begin in early 2021, investors with a long-term mindset and above-average appetite for risk might want to give this company a closer look.