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Down 25% in 2021, Is Compass Pathways Undervalued?

By Alex Carchidi – Oct 22, 2021 at 6:55AM

Key Points

  • Determining the value of a stock means making assumptions about its future growth.
  • Psychedelic treatments may be significantly more effective than legacy medicines for certain mental illnesses.
  • Short-term price movements usually aren't worth paying attention to.

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It depends on how optimistic you are about its lead program.

If you've ever been depressed, you know how difficult it can be to get a leg up on getting back to a sound state of mind. To help people suffering from depression and other mental illnesses, Compass Pathways (CMPS -0.29%) makes psychedelic therapies based on chemicals like psilocybin. While its interventions may never be as widely used as the first-line depression treatments of today like cognitive behavioral therapy (CBT), they just might offer a source of hope. 

But hope isn't enough when it comes to making fruitful investments in biotech. Compass' shares are down by more than 25% from the start of the year, and there's no guarantee that they'll recover. Let's examine this company and its stock to see if the market is getting it wrong.

Person in cafe looking at computer and papers.

Image source: Getty Images.

Valuation isn't an exact science

Since its initial public offering (IPO) in September of 2020, Compass has been busying developing its psychedelic therapies. Because it doesn't have any products approved for sale yet, it presently has no revenue or earnings to speak of. So, it's impossible to use standard valuation metrics like the price-to-sales (P/S) or price-to-earnings (P/E) ratios to get a feeling for whether its current price is in the right range for prospective buyers.

But with a little analysis, we can still get a rough sense for Compass' valuation relative to its peers in biotech. With its lead program, the company intends to address treatment resistant depression (TRD), which is estimated to affect more than 100 million people worldwide.

Compass' COMP360 treatment is comprised of a psilocybin drug administered alongside guided talk therapy, and early studies show that the combination is highly effective at treating TRD. The program is currently in phase 2b of clinical trials, which means that there's a solid chance it will be competing in the TRD market in a few years.

By definition, people who have TRD have already tried at least two other interventions, meaning that the standard slate of options like traditional antidepressant drugs hasn't brought them relief. Beyond those, there are a handful of more invasive approaches like electroconvulsive therapy (ECT) that aren't used for less severe depression, but can be used to try to help people with TRD.

Still, those therapies tend to have difficult side effect profiles, and they are far from a panacea. Therefore, if COMP360's strong efficacy continues to be supported by clinical evidence and its benign side effect profile makes it more appealing to patients, it'll have an edge over the other therapies on the market.

Let's take a look at a quick calculation to get an idea for the share prices that a future COMP360 approval for TRD might support. Per a report by Credence Research, the global market for TRD therapies will be worth $1.39 billion by 2027. And the biotechnology industry's average price-to-sales multiple is 4.7. Thus, if Compass manages to capture a mere 10% of that per year, it could be bringing in $139 million in revenue. Assuming that it trades at the industry's average P/S ratio, its shares could be worth at least $15.66.  

Currently, Compass' shares go for around $35, though. That means the stock is either massively overvalued, or that there are other potential future revenue sources of note which the market is accounting for with its current price.

Psilocybin might be useful in more common varieties of depression

In the long run, it's possible that COMP360 will be proven useful for wider indications within the field of depression and its related disorders. The company is already conducting research with the help of collaborators to evaluate the therapy's efficacy for major depressive disorder (MDD), suicidal ideation, and bipolar disorder. If COMP360 performs favorably in these other niches, that'd mean it could access a much larger addressable market than with TRD alone. 

And having a larger market would do wonders for the valuation. Per Mordor Intelligence, the global antidepressant drug market will be worth as much as $17.23 billion by 2026. Capturing even 5% of that market would be worth $861.5 million per year, which could give Compass a share price of around $97 at the biotech industry's average P/S ratio valuation.

So, if we assume that the company can take its initial successes with COMP360 and TRD and replicate them with MDD, it's reasonable to say that the stock is currently massively undervalued. Only future clinical trial results will tell the story with certainty. 

In the meantime, I'm still comfortable with buying the stock today. While it's definitely a speculative and risky buy, the scientific evidence I've seen indicates that psilocybin is indeed a highly promising treatment for many different mental illnesses, and especially for depression. And at the end of the day, having a better product than the competition is key, even if there's still work to be done to prove it.

Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends COMPASS Pathways plc. The Motley Fool has a disclosure policy.

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