Avoid This Biotech Stock

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Sources: S&P Capital IQ, Yahoo! Finance, and Motley Fool CAPS.

This Week's Pitch:
With this pick, I now have 9 of the 80 thumbs Ironwood has garnered in the 20 months since I announced the company's birth to CAPS. For some reason my interest in the stub is disproportionate to that of the community as a whole, but I find their volatility fascinating as well as profitable in terms of CAPS points and accuracy.

The bull story for Ironwood is the run up before the PDUFA for irritable bowel drug linaclotide in June 2012. There's a very high likelihood that the FDA will approve the drug, given solid phase III data and an unmet medical need. They also have strong partnerships for the drug in the US and Europe. That makes Ironwood an attractive buy under 10.

The bear thesis is that regardless of what happens with the PDUFA, the vast majority of newly approved drugs from small and mid-sized pharmas have been disappointing underperformers in sales. This may or may not happen to linaclotide, but several quarters will be necessary after approval before Ironwood can prove they can justify their lofty valuation. After approval, traders will flee the stock and it will almost certainly dip even if the drug eventually proves successful. Meanwhile, Ironwood has no track record of FDA success and it is very possible that the FDA may find sufficient flaws in the NDA to justify a CRL. Given the lack of other compounds in clinical trials, that outcome would crush the stock. Put options might be interesting if the share price rises back above 16 prior to the PDUFA.

Despite the fact that events have unfolded in a very predictable manner, the stock has been extremely volatile over the last year. Traders seem to think that global economic events somehow affect the likelihood that linaclotide will be approved by the FDA. Today they seem to have become much more optimistic about linaclotide because of a new European bailout plan for Greece. Weird.

Well, here's the thing. I've heard this bailout story half a dozen times over the last two years and I'm not buying it. The more everyone else buys it, the harder the market will crash when it turned out that it didn't really make any difference and Greece is going to default after all. And when that happens, Ironwood stock will be headed back to 10 or lower if the previous pattern holds.

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