Shares of Compass Pathways (NASDAQ:CMPS) have soared since the company's recent stock market debut as support grows for the use of popular recreational drugs to combat depression.

Can the highly refined version of magic mushrooms that Compass Pathways is developing for depression give your portfolio a lift too? Let's weigh some reasons investors are excited about this alternative biotech stock against some of the challenges that lie ahead.

Person considering a stock purchase on their laptop.

Image source: Getty Images.

Why magic mushrooms?

Mushrooms that contain psilocybin are well known for their ability to temporarily make you see and hear things that aren't real. More recently, smaller doses have been gaining popularity as a mood enhancement tool despite being a controlled substance that's illegal to sell or possess in the United States. 

Pick any organ in the body, and you'll find thousands of scientists who can describe how it functions in health and disease with stunning levels of detail. Unfortunately, the brains between our ears are an exception that humbles the scientific community so deeply that drug developers are willing to try just about anything that appears to provide a benefit.

Wall Street likes the idea Compass Pathways has latched on to, which involves using psilocybin, the active ingredient in magic mushrooms to treat depression. In September, the company raised $147 million in an initial public offering (IPO) and since then the stock has risen around 64% in anticipation of clinical trial results expected next year.

Reasons to buy Compass Pathways stock

Millions of positive anecdotal reports and a growing pile of peer-reviewed papers suggest psilocybin can work for patients who suffer from major depressive disorder despite treatment with standard care. Compass Pathways is founded on the fairly reasonable assumption its proprietary formulation of psilocybin, COMP360 will produce clinical trial evidence the FDA needs to see to grant it approval for this large, underserved population.

Each year, around 7% of adults in the U.S. experience at least one major depressive episode, and for most, these episodes severely impair work performance and the ability to maintain close relationships with friends and family. Today's available treatments don't always get the job done and worldwide, an estimated 100 million people with treatment-resistant depression (TRD) are clamoring for new treatment options.

If Compass can earn approval to treat a huge population of underserved TRD patients with its proprietary psilocybin formulation, annual sales could reasonably pass $1 billion within a few short years of a successful new drug launch.

Compass Pathways' psilocybin treatment, called COMP360 has already cleared an important safety hurdle by not causing any serious side effects during a phase 1 trial with healthy adults. The company's currently running a phase 2 trial that will enroll 216 patients that actually have TRD, and positive results when the study reads out in 2021 could cause this stock to rocket higher.

Scientists at work.

Image source: Getty Images.

Reasons to be nervous

Despite beginning its phase 2 trial in January 2019, Compass Pathways still hasn't finished enrolling 216 patients from a population of millions. Compass Pathways has explained that it isn't easy to find patients willing to taper off from their current medication and remain off it for weeks on end to receive one dose of COMP360. 

Asking TRD patients to stop taking their current medication to try an experimental treatment isn't necessarily a dealbreaker, but physicians aren't going to be eager to recommend more than a few of their patients if the first few to report back aren't impressed. 

Unfortunately, slow enrollment isn't the only reason we'll have to wait a long time before we know if Compass Pathways has any shot at commercial success. The phase 2 trial that is progressing at a snail's pace will randomize 216 patients to receive one of three ascending doses of CAP360, but the study doesn't include a control group.

Meaningful benefits from experimental anti-depressants are excruciatingly difficult to measure partly because you never know which patients were finally about to improve on their own. Spending years to produce data from a trial without bothering to include a control group suggests this company isn't in any hurry to find out for certain whether COMP360 has a real chance of becoming a commercial-stage drug.

Performing without a net

At recent prices, Compass Pathways sports a $1.7 billion market cap but the company can't begin to tell you when to expect any reliable revenue. If support for CAP360 fizzles, there aren't any other experimental drugs in the company's pipeline to keep the stock price from collapsing.

Compass Pathways finished September with $197 million in cash after its operations burned through $40 million during the first nine months of 2020. Drug development expenses multiply with every step a new drug candidate takes toward the finish line, so we can expect another dilutive stock offering shortly after this risky biotech company reports phase 2 results for CAP360 next year.

In November, an independent group of investigators began a trial with 15 TRD patients and the highest dosage of CAP360 that Compass Pathways is using in its phase 2 trial. If we see some compelling results when this independent study wraps up in January, we'll circle back to Compass Pathways as a potential investment. For now, though, it's best to watch this interesting story unfold from a safe distance.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.