Biotech stocks had a rough 2022. Speaking to this point, the SPDR S&P Biotech ETF sank by an eye-catching 25.8% last year. Concerns about a stricter Food and Drug Administration (FDA), rising interest rates, and a growing aversion to risk weighed particularly heavily on clinical and early commercial-stage biotech stocks. The silver lining, if you can call it that, is that the small-to-mid-cap biotech landscape is now chock-full of companies trading at a steep discount relative to their long-term value proposition. 

Which of these beaten-down biotech stocks is the most compelling buy in March? While there are a surfeit of candidates, Acadia Pharmaceuticals (ACAD -1.55%) stands out as an intriguing buy ahead of its upcoming Prescription Drug User Fee Act target action date of March 12 for the experimental Rett syndrome candidate, trofinetide.

Acadia licensed this novel synthetic analog of the amino‐terminal tripeptide of IGF-1 from the Australia-based Neuren Pharmaceuticals (NEU 0.19%) in 2018. If approved, Acadia and Neuren would sport the first medication specifically designed for this rare neurological disorder.  

Researchers in a lab.

Image source: Getty Images.

What's the value proposition?

Acadia currently has one FDA-approved drug, Nuplazid, indicated for the treatment of hallucinations and delusions associated with Parkinson's disease psychosis (PDP). Nuplazid generated net sales of $517.2 million in 2022.

Despite this hefty sum, Acadia still posted a net loss of $216 million last year due to its sizable research and development expenses. Favorable tailwinds such as an approval for trofinetide in Rett syndrome and the conclusion of other late-stage programs could transform the company into a cash flow-positive business as soon as next year. 

What's trofinetide's commercial opportunity? Acadia has estimated trofinetide peak sales at approximately $500 million per year. This estimate, however, may be overly conservative. As a drug indicated for a rare condition, trofinetide will certainly garner a premium price point.

What's more, the Rett syndrome patient and healthcare provider communities are well aware of the drug's existence, a fact that bodes well for its uptake upon a potential approval. So in short, the drug's total addressable market in the Rett syndrome setting appears to stand at anywhere from $1 billion to perhaps $5 billion, depending on pricing, reimbursement status, etc.

This wide range complicates matters in terms of understanding the drug's value proposition to Acadia -- at least in the short term. Wall Street analysts, though, appear to be taking a cue from Acadia's internal estimate of roughly $500 million per year in peak annual sales. And that's what matters when it comes to where Acadia's stock might be headed in the event of an approval next week. 

Right now, Acadia's stock is trading at approximately 6 times 2023 estimates sales. That's not a sky-high premium, but it is high enough to assume the market is already baking in some of this potential Rett syndrome-related upside.

So in a market that is no longer handing out ginormous premiums to biotech stocks, it's not unreasonable to assume that Acadia's stock may trade at somewhere around 4 times 2028 net Rett and PDP sales post-trofinetide approval. Under this conservative-leaning scenario, Acadia's stock would be fairly valued at $25 a share (21% implied upside potential from current levels). 

Is Acadia stock worth the risk?

The cautionary part of this tale is that an approval is far from guaranteed. This latest iteration of the FDA has been exceedingly unpredictable when it comes to regulatory timelines and decisions. As such, investors should definitely consider the downside risk in the event trofinetide is rejected. 

Fortunately, the downside risk calculation in this case seems fairly straightforward. Since the start of the year, Acadia's shares have jumped by 29%, with most of these gains seemingly attributable to this singular upcoming catalyst (the company didn't release any other needle-moving news since the start of the year, after all). So, overall, Acadia's stock probably has a 21% near-term upside potential following an approval, and a possible 29% downside risk upon a rejection.  

Normally, this unfavorable risk-to-reward ratio would be off-putting. However, the publicly available clinical trial data seems to favor an approval in this case -- with the main question mark centering around trofinetide's side effect profile.

Moreover, there is an interesting deep-value component to this story: Trofinetide could not only help to transform Acadia into a cash flow-positive operation, but the drug's sales would undoubtedly go toward funding other value-creating activities in the years ahead. 

All told, Acadia's stock ought to appeal to aggressive growth investors who are comfortable with volatile price swings.