Street Talk: Small-Cap Biopharmaceutical Stocks

While small caps are more volatile than their large-cap brethren, they offer benefits galore to investors of all stripes
Aug 01, 2007
Volume 20, Issue 8

Brian O'Connell
It's the dog days of summer and there isn't too much happening on the larger life sciences financial front. As I write this, second quarter results are just starting to trickle in, with Genentech leading the way. If Genentech is any indication, the quarter should be a mixed bag, with a little something for everyone. Genentech beat analyst expectations, earning $0.78 per share against analyst expectations of $0.72 per share. Particularly encouraging to the South San Francisco-based pharmaceutical giant were sales of its cancer-fighting drug Avastin, which soared 33% for the quarter to $564 million.

Long-range, Genentech raised its full-year profit outlook to a range of $2.85 per share to $2.95 per share, excluding charges. It had expected to earn $2.79 to $2.90 per share. But analysts say that the figures rely on a rosier-than-reality outlook for Avastin for the rest of 2007. Also, sales of other key drugs, like Herceptin and Lucentis, need to remain steady. Genentech's flagship product, the rheumatoid arthritis and non-Hodgkin's lymphoma drug Rituxan, saw $582 million in sales during the quarter, an 11% increase. If Rituxan can keep that up, then Genentech should be a big winner by year-end.

But it is not the big boys like Genentech that I'm focusing on this August. It's the smaller stocks that operate in the bigger life sciences orbit that deserve some scrutiny. That means stocks like Tercica (TRCA), which recently has seen its stock price grow by 25% after an announced agreement with Genentech to pay $53 million to combine its Increlex with Genentech's Nutropin, a growth hormone, to form a once-daily injectable treatment for children who don't grow normally. As a result, Tercica's market cap has skyrocketed to $270 million, even after posting an operating loss of $86 million in 2006.

On the other end of the small-cap spectrum is another biotech firm with a hefty market cap, but with much different prospects than Tercica. The company is Depomed (DEPO) and is trading down under $2 per share, after trading as high as $5.80 per share. As one Internet wag put it, Depomed was a "one trick pony . . . that in this case, the pony died." According to the Associated Press, Depomed's stock suffered after "results of a late-stage clinical trial of its Gabapentin GR extended release tablet for nerve pain didn't show significant effectiveness versus placebo." After losing $42 million in 2006, even with a market cap of $200 million, Depomed looks like it is on its way out.


The dichotomy between the likes of Tercica and Depomed defines the small-cap biopharmaceutical world, where risk is high but so is return.

Few investment asset classes offer both the risk and reward that small-cap stocks provide. While small caps are certainly more volatile than their large-cap brethren, there's little doubt that, historically, small caps offer plenty of benefits to investors of all stripes. That's especially true of small-cap biopharmaceutical stocks, which, as measured by the NASDAQ Biotech Index, have far outpaced the growth rates of their large-cap brethren.

So what are small caps? They are companies with a market capitalization of $1 billion or less. Market capitalization can be calculated by taking the number of outstanding shares and multiplying by the current per share price.

Experts agree that small-cap stocks, especially those with market caps under $500 million, are riskier investments, but have higher profit potential. By and large, the lower the market cap, the more vulnerable the investment. So small-cap stocks with market capitalizations under $500 million represent a much greater investment risk than small cap stocks with market caps twice as large.

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