Another Gem for the Biotech Basket

 | Jul 28, 2014 | 12:00 PM EDT
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Back in June, I wrote about building a stock basket of biotechnology stocks. The idea was simple: When it comes to this sector, it's more important to know what you don't know, rather than on focusing on what you do know. The stark truth about biotech stocks is that the majority of them never transform into a business with a commercial product -- and, as a result, they hold no true investment value. In other words, they are purely speculative.

On the other hand, some companies truly do hold promise, and the result is often very skewed to the upside. In my prior article, for instance, I referenced the 230% premium that Merck (MRK) agreed to pay for Idenix Pharmaceuticals (IDIX).

Biotech stocks offer returns that are usually dispersed on both tails of the bell curve, so I suggested that a basket be a sensible approach to investing in these companies. This approach is perhaps more critical than ever now: Last month, the Federal Reserve specially called out biotechs as overvalued, and those comments immediately sent the sector down.

My initial basket is small. While there are dozens of candidates, I wanted to limit the basket to names that have been screened out by other investors -- and are in their portfolios -- or to companies with drug candidates that are in latter stages of the Food and Drug Administration's approval cycle.

Between June 2 and last Friday, the basket has shown impressive results. Kindred Biosciences (KIN) is up approximately 6.5%, Aveo Pharmacueticals (AVEO) has gained 14.7% and Keryx Biopharmaceuticals (KERX) is up nearly 16%.

Today, I'm adding a fourth name to the basket: Minerva Neurosciences (NERV), a small-cap offering candidates for treatment of diseases afflicting the central nervous system. Minerva had its initial public offering several weeks ago at $6 per share. So far the stock has traded tightly, between $5.57 and $7.54. Today, shares trade for just under $7, making for market capitalization of $124 million.

Minerva has two lead candidates that have completed Phase IIa trials, so that fulfills the latter of my two requirements. As for the pre-screened condition, Care Capital owns 3.8 million shares of Minerva, or 21% of the company, after it having bought an additional 737,500 shares at the IPO price of $6. Another group, Index Venture Associates, also owns 2.8 million shares -- 15.4% -- also after an additional IPO purchase of 1.3 million shares.

What's interesting is that both of these investment groups had owned a nice chunk of this company pre-IPO, and that they basically decided to double down and buy more on the public debut. For the general public, shares of Minerva still trade for close to the IPO price.

Again, this basket will be very a selective one, and these decisions will consistently be based on the two conditions I've noted above. Minerva, a very intriguing name, passes both conditions.

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