Wall Street pros have nothing on retail investors who stake small sums of money monthly on undervalued small-cap stocks. Because they're mostly ignored by the big guns, these types of stocks offer the best, outsized opportunities for growth.
I screened for stocks under $3 billion in market cap, offering earnings surprises of 15% or more in the previous quarter, with long-term earnings growth forecast to be at least 15%. One stock that floated to the top was drug developer Zogenix (NASDAQ:ZGNX), whose stock got boxed around the ears last month after a Food and Drug Administration advisory panel voted 11-2 against approving its new pain medication Zohydro ER. But because it does have another drug on the market. It narrowed losses in the third quarter to $0.21 a share from $0.59 a year ago and 25% ahead of Zacks analyst expectations. As they anticipate its earnings to grow 25% annually for the next five years and with a $155 million market cap, it easily makes it into our range for potential investment candidates.
Of course, don't jump on a stock just for those reasons. It should just be a starting point for more research as we need to look more closely to see whether analysts' faith in them is well-founded.
Abusing the privilege
The FDA is serious about preventing drug abuse. It's tasked pharmaceuticals and biotechs with devising ways to prevent addicts from breaking down their drugs and abusing the compounds derived from them.
It was the production of OxyContin that got the ball rolling, since by crushing the pills an almost pure form of the opiod oxycodone could be released. As abuse of the drug soared, the FDA said that all drugmakers that sell long-acting and extended-release opioids had to establish a single comprehensive plan to instruct doctors about how to make sure the patients that need the drugs get them but that they stay out of the hands of drug abusers. Privately held Purdue Pharma, which makes OxyContin, ended up developing an extended-release version that contained binders making it difficult to crush the tablets.
Other drug manufacturers have followed suit in their formulations. Pharmaceutical giant Pfizer (NYSE:PFE) is working with Pain Therapeutics (NASDAQ:PTIE) to develop a version of oxycodone called Remoxy that uses an additive from Durect (NASDAQ:DRRX) to create a taffy-like capsule that prevents it from being crushed, snorted, or injected. Pfizer previously got approval for abuse-resistant oxycodone med Oxceta that was developed by Acura Pharmaceuticals (NASDAQOTH:ACUR).
Johnson & Johnson (NYSE:JNJ), Teva Pharmaceuticals (NYSE:TEVA), and Mylan (NASDAQ:MYL) are all on the same page in devising abuse-resistant drugs. Even smaller players like Zalicus (NASDAQOTH:EPRSQ) have had to develop extended-release pain meds, such as its pain management therapy Exalgo. Nektar Pharmaceuticals (NASDAQ:NKTR) is pursuing a novel molecule structure that provides significant pain relief but inhibits the rate at which the drug can cross the blood-brain barrier. NKTR-181 is in phase 2 clinical testing.
Ain't that a surprise
So Zogenix might have been a bit surprised by the overwhelming lack of confidence the FDA panel exhibited for Zohydro ER, which uses a drug delivery technology from Alkermes (NASDAQ:ALKS) for extending the pain release qualities of the underlying hydrocodone. Pfizer used a similar technology to get a new morphine product approved, as did Jazz Pharmaceutical's (NASDAQ:JAZZ) in its OCD drug Luvox and Novartis (NYSE:NVS) for its ADD treatment Ritalin.The sticking point seems to be that the pill itself wasn't crush-resistant. That suggests to me that despite the outsized vote against it, the full body may yet approve it. That gives the drugmaker some large upside potential.
First, the FDA doesn't have to follow the recommendations of its panels, and often times it goes its own way. Then there's its DEA Schedule II classification that puts it on par with other hydrocodone drugs meaning it won't be easily obtainable. Considering the safety profile of the drug and the risk evaluation and mitigation strategy submitted by Zogenix with its application, it seems there's at least a cogent argument to be made in the drug's favor of ultimately getting approved.
While there are risks inherent in investing in biotechs and small drugmakers, I think they've been priced into Zogenix's stock at this point. Shares are down 55% from its highs, and though they're slowly making their way higher again I foresee a surge as it approaches the March 13 meeting date with the FDA. I've gone and rated the drug maker to outperform the market on Motley Fool CAPS, the 180,000 member-driven investor community that translates informed opinion into stock ratings of one to five stars.
It's a risky bet since the FDA is a fickle master, but let me know in the comments section below if you agree there's more to like in this story than the bears would have you believe.
Fool contributor Rich Duprey owns shares of Pfizer. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.