Small companies in the healthcare field are appealing to those with an appetite for risk. The potential for profit should you invest in the company that finds a viable cure for a type of cancer or makes advances in the treatment and prevention of Alzheimer’s are obvious and enormous. Similarly, medical equipment or technology that become an accepted part of treatment for common diseases offer massive profit potential.
Of course, as you are no doubt well aware, in markets the cost of opportunity is risk. Small companies with potential in the healthcare field also face enormous risk. The most common one is that an initially promising drug or treatment has no value (at least in the US) until FDA approval is granted. If and when that glorious day comes, however, it doesn’t mean that risk is over.
As companies in every field known to man have discovered since commerce began, a great product is only part of the story. You still have to produce enough of it to satisfy demand, price it correctly, market it to make sure people are aware of it, have a sales staff that can sell it and a distribution system that gets it to them. Put simply, once approval has been granted, strategy and execution matter.
There are two small healthcare stocks, both listed on NASDAQ, which could be set for banner years in 2014; each for a different reason and each with a different risk profile.
Chelsea Therapeutics (CHTP):
Chelsea Therapeutics is a Charlotte, NC based company that fits what most people imagine when they envisage small healthcare stocks. They have a product that could prove effective in the treatment of a disease, and for which they are awaiting FDA approval. The drug is Northera, designed to treat the symptoms of orthostatic hypotension in Parkinson’s, multiple symptom atrophy (MSA) and pure autonomic failure.
Orthostatic hypotension is a sudden lowering of blood pressure resulting from a change of position, such as standing up. It causes extreme dizziness and often fainting, leading to injury risk for sufferers. I know this because my father in law, who passed away a few months ago from a non-Parkinson’s autonomic disease, suffered badly from the problem in his last year or so. It was the orthostatic hypotension that confined him to a wheelchair initially more than anything.
I mention this because it is possible that my belief in a company seeking a treatment could be colored by that experience. You can decide, but I believe there are solid, logical reasons why CHTP may be worth the risk going into 2014. The market for such a drug is small, but Northera has a chance to own the market in its totality.
As you would surmise looking at the chart above, CHTP has come close to approval for Northera in the past, only to have their hopes dashed. Most recently, in February of 2012 the FDA advisory panel recommended approval of the drug, but the administration denied that approval, citing a need for more evidence of the long term efficacy of Northera. CHTP has submitted new trial data, with an advisory panel recommendation expected on January 14th 2014, and the full FDA decision 1 month later.
The potential for the stock should that be a favorable decision is significant. The company has a current market capitalization of around $293 Million but estimates annual sales of Northera to reach $300-375 Million within 5 years. If approval is given, therefore, a doubling of the current share price just below $4 is a distinct possibility.
The risk, however is large. There is no point in setting a stop loss in a situation like this, as in the event of further delay or outright rejection the stock will gap down, probably to previous lows close to $1.00, representing a 75% potential loss. Obviously, then, this is a candidate for only a small investment, but the company knows what is required, having already gone through the process and believes they have sufficient trial evidence to gain approval. On balance, I believe it is a chance worth taking.
Accuray Inc. (ARAY):
Accuray, a California based oncology company, represents a different kind of risk. Their “CyberKnife” is a robotic radiosurgery system, used to remove tumors. It has approval and is becoming increasingly accepted. For Accuray, strategy and execution have, until recently been the problems.
ARAY reported results for the first quarter of FY 2014 in November, and showed both an increase in sales and, more importantly to many, a reduction in costs. The company has yet to move to full profitability, but recent moves to control overhead, coupled with increasing sales, would suggest that day is not too far away.
Execution risk, such as in this case, is a little easier to limit than the regulatory risk faced by CHTP. If sales falter or costs increase there will be a reaction following the relevant earnings release, but it probably won’t be catastrophic. I would leave room for the normal fluctuations of a volatile stock, but a stop loss guarding against a break of the frequent support at around $6 would limit potential losses somewhat.
Investing in small cap healthcare stocks with potential is not for the faint of heart. There are always great risks, but not always from the same source. ARAY and CHTP exhibit different types of risk, but both have the potential for significant price appreciation early next year and a small investment in each could pay off. If nothing else, you will have the satisfaction of knowing that you invested in something that could make the lives of millions of people better, and for many that is reward enough.