I'm Rich! I'm Ruined! Overreaction Equals Opportunity

Sometimes investors' reactions puzzle me. Feeding off of just a single piece of information, shareholders can cause wild swings in share prices.

Sounds like opportunity knocking to me.

Take a look at how these two drugmakers have fared over the past week:

Source: Yahoo! Finance.

They're both cash-burning drug developers, so based on their share price change, you'd think that Dendreon had released positive data and Amylin's drug had flopped. Nope, not even close.

Anticipation
Dendreon's rapid appreciation appears to be because the American Urological Association gave the company time on April 28 to present data at its annual meeting. The company had already said in January that the data from the final trial for its prostate cancer treatment, Provenge, would be available in April, so the timing shouldn't have surprised anyone.

Giving the company time to talk at the conference isn't an indication that the trial was successful. Drug companies are increasingly presenting negative results -- Eli Lilly (NYSE:LLY) and Schering-Plough (NYSE:SGP) both did it recently -- and it's unlikely that anyone at the association knows the results anyway. When Dendreon applied for the timeslot, the employees probably didn't know the results -- and may not even know now.

Investing in drug developers is about estimating the chance of clinical trial success or approval by the Food and Drug Administration and then making sure you're being rewarded accordingly for taking on that risk. As Dendreon increases in price, the potential reward from a positive result decreases, and there's no clear sign that the risk of failure has gone down.

I see that as a sign to sell -- or at least to trim your holdings. You'll miss out on a huge increase if the results are positive, but holding on for that potential looks like a big risk to me.

Shades of gray
Amylin's share price fall didn't have anything to do with its drug directly, and while recent news did add some risk to the potential for an FDA approval of its once-weekly Byetta, it seems like investors have overreacted.

Last Thursday, an FDA advisory panel deadlocked over whether thyroid cancer seen in rats and mice given Novo Nordisk's (NYSE:NVO) diabetes drug, liraglutide, was a reason to keep the drug off the market. Because liraglutide is in the same class of drugs as Byetta, investors are worried that the cancer issue could also delay approval of Byetta's once-weekly version, which Amylin and partner Eli Lilly will submit to the FDA for marketing approval shortly. Alkermes, which is due to receive royalties from the drug, has also been beaten up over the last few days.

The lack of a ringing endorsement from the panel of experts lowered the likelihood of approval of liraglutide, but the side-effect profile isn't identical for the two drugs, and the panel's vote doesn't hurt once-weekly Byetta as much as it does liraglutide. While thyroid cancer in liraglutide was seen in male and female rats and mice at levels equivalent to what a patient would take, thyroid tumors were seen only in female rats given once-weekly Byetta at doses corresponding to more than three times what a patient would take.

There is no doubt that the cancer data adds risk of a FDA delay for once-weekly Byetta, but I don't think it's as dramatic as investors have made it out to be. This drug has the potential to be a blockbuster if it makes it onto the market and investors will be rewarded handsomely from this level if it does.

Value or value trap
The secret to knowing whether the dramatic rise or fall in a stock is a signal to buy or sell is to understand the company in and out. Whether it's drugmakers, financial companies like Citigroup (NYSE:C), or automakers like Ford (NYSE:F), you can't make rash decisions on whether to buy in (or sell out) unless you're keenly aware of what the value should be.

Buy and hold isn't dead, and I'm not advocating for commission-churning day trading, but when the market gives you a blue-light special, make sure you jump on it.