Endocyte, Inc. (ECYT) is a micro-cap biotechnology company that just doubled in value on the stock market.
The company’s experimental cancer drug, originally targeting ovarian cancer, is being developed in concert with Merck & Co., Inc. (MRK), which licensed the drug’s development a while ago for an upfront payment of $120 million.
This is exactly the way a small biotechnology company should develop.
Biotechnology is big money and a favorite of institutional investors. Equity portfolios are well served by having some exposure to this sector, but only with a small allocation because these stocks are 100% risk-capital securities.
The universe of biotechnology stocks is vast and like commodities, they move with their own particular brand of mania.
If you come across news of a large pharmaceutical company licensing a much smaller company’s drug candidate/technology, then it’s worth putting the opportunity on your radar. Drug development expenses are so significant (and time-consuming) that sharing the costs and potential rewards is a worthwhile corporate strategy. And by doing so, the pharmaceutical company with deep pockets helps to legitimize the story, thereby attracting a whole new set of investors.
Not surprisingly, Endocyte moved higher after its original licensing deal with Merck. But afterward, the stock traded sideways for quite a while as the drug development phase took its course. The company’s one-year stock chart is featured below:
Chart courtesy of www.StockCharts.com
Biotechnology investing is a unique endeavor, as the business model is much different than traditional enterprises. The risks are significant, and speculating in this sector is not appropriate for conservative portfolios.
As Endocyte illustrates, it can take a material amount of time for a speculative investment to pay off—if it even does so at all.
Large-cap biotechnology companies are well covered by research analysts and institutional participation is strong. Previously in these pages, we looked at Biogen Idec Inc. (BIIB) and Alexion Pharmaceuticals, Inc. (ALXN). (See “Why Momentum Traders Love These Stocks.”)
These are powerhouse companies with very strong growth prospects; however, they can be very pricey and subject to massive volatility.
Biotechnology stocks are securities that you can identify and watch to get a familiarity with a story and how a particular company trades on the stock market. If a developing company is successful, it still has to go through many stages even before it can generate any sales let alone be profitable.
That’s why you have to have a lot of patience with these stocks. A lot of money gets raised then spent without any material progress.
Endocyte is a developing company with a bright future. The $120-million investment by Merck is not immaterial, and it’s still lending a lot of credibility to this particular story. After a good amount of time, the story paid off but the journey up to now has still been 100% speculative risk.
Generally speaking, I feel that the current environment is a good one to consider lightening up on speculative winning positions. This applies to biotechnology stocks, many of which recently began rolling over on the stock market.