Profiting on Small-Cap Biotech Earnings

There are a lot of perplexing things that happen in the market, which is understandable given that equities are driven by daily decisions made by millions of individual investors, fund managers and increasingly, by trading algorithms within the black boxes of high frequency traders. Sometimes this results in some decisions that look downright silly in hindsight. One that immediately comes to mind is the 30% to 40% decline over two weeks during the summer a few years back in airline stocks. This quick and brutal downturn was triggered by the belief -- fanned by a media frenzy -- that the ebola outbreak was coming to the developed world, including the United States. Anyone that actually knew how hard that disease is to spread given proper sanitary conditions could have realized that the chances of that actually happening were somewhere between slim and none. But driven by images, real and imaginary, of that horrid disease, investors bolted out of airline stocks -- at least for a short time, until sanity returned to this part of the market. One irrational thing that happens over and over again that always amuses me, and usually is one of my best short-term profit-making opportunities, is investors trading in and out of small developmental stage biotech companies on quarterly numbers. These are companies largely with no recurring earnings or revenues to speak of, so these numbers are usually the result of timing or other non-sequitur factors. But big moves off these irrelevant numbers happen all the time. Take the action in Ardelyx (ARDX) this week. The company reported a loss of $0.70 a share, $0.04 below the consensus, after the bell on Monday. The stock was down more than 10% in trading Tuesday before starting to recover. Ardelyx is a late-stage development concern that could have three new drug application (NDA) filings by the end of 2017. The company now has a market capitalization of around $250 million, of which some $180 million is net cash on the balance sheet. All of its trials are proceeding as planned, and if anything, the conference call, for those investors who bothered to listen to it or read the transcript, was more than upbeat. So basically, nothing changed for this company's outlook or prospects other than non-existent earnings missed by an arbitrary $0.04 a share. This also happens to companies that are just at the beginning of commercialization stage -- where they are still building their sales forces, expanding network coverage and getting into formularies. Revenue is always quite bumpy the first quarter or two of every rollout, and these stocks can be punished severely on arbitrary headline numbers. The knee-jerk selloffs in BioDelivery Sciences (BDSI) and Omeros Corporation (OMER) this week on quarterly numbers are good examples. One thing I have found over two decades of investing in this space is that these stocks usually recover in subsequent weeks, as clearer thinking returns to the market and investors realize nothing material has changed for these companies -- despite the headline miss. Irrational responses go in the other direction as well. Yesterday, TG Therapeutics (TGTX) rose more than 6% intraday, before coming down with the deep biotech selloff, to post a slight gain on the day. The company lost $0.28 a share on the quarter, $0.08 better than estimates. Revenue was less than $50,000, which was slightly better than expected. Oy Vey! I have found in the past that these selloffs can be good be good opportunities to incrementally build in a position in these small, speculative concerns, as in most cases nothing materially has changed on the company's long-term outlook. One does not have to understand the emotions of the market to profit from them.

Profiting on Small-Cap Biotech Earnings

Don't trade the headline numbers, but cash in on those traders that do.

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