It was a pretty brutal trading day on Wednesday after Arrowhead Research (ARWR) announced that its Hepatitis B treatment, ARC-520, had failed to return positive top-line results. The news hit the markets at 10:00 am EST, making for a rare instance where the bottom falls out from under a stock during an actual trading day.
And boy oh boy did that bottom drop out. The company’s stock took a 44.12% hit on the day on volume that was more than 14 times its daily average. That’s a heavy decline that demonstrates just the degree to which sub-par clinical results for ARC-520 represents the pin that popped the balloon of Arrowhead’s valuation.
August Euphoria Followed by October Sorrow
If you were listening to Arrowhead President and CEO Christopher Anzalone, the data, which will be presented at the American Association for the Study of Liver Diseases’ (AASLD) Liver Meeting.
“ARC-520 represents a novel approach for the treatment of HBV with the potential to achieve functional cures,” he said. “Our ongoing Phase 2a dose finding study is an important step, and in cohort 1 at a dose of 1 mg/mg and cohort 2 at 2 mg/kg we saw a clear reduction in HBsAg, the surface antigen of HBV. Data collection for HBsAg reduction in cohort 3 at 3 mg/kg is still ongoing, however we are pleased to report that all three dose levels have been well tolerated in patients. These results give us great confidence as we move forward with designing and initiating several upcoming Phase 2b studies of ARC-520 and the ARC-AAT Phase 1 study.”
Which would sound like something other than a desperate effort to spin obviously negative results based on expectations were it not for the aforementioned massive crash in the company’s valuation that almost immediately followed the release of the data. As TheStreet’s Adam Feuerstein pointed out, part of the issue could be that the results teased in August may have been oversold to investors. As such, the collapse of the company’s stock is likely just reflecting the degree to which enthusiasm over ACR-520 delivering big results had puffed up Arrowhead’s valuation in the first place.
What’s Next for Arrowhead Research?
On some level, Anzalone’s comments aren’t without merit. As Feuerstein pointed out later in the day, the biggest issue with the results wasn’t so much the results themselves but the results as gauged against the high expectations created among investors. Today hardly marked a death knell for the future of ARC-520, it simply revealed that the drug wasn’t the sort of blockbuster many were hoping for.
Moving forward, ARC-520 may yet prove to be an effective Hep B treatment at higher doses, in which case a lot (but probably not all) of the value lost today could likely be made back. The company’s also got a more robust pipeline than just ARC-520, offering other opportunities to create value even if its lead therapy does ultimately prove a dud.
All told, the day’s market movement may have mostly represented a correction in response to what was clearly overenthusiasm earlier in the year.
This Small-Cap Star is Not Shining at the Moment
Arrowhead also offers up a fairly important lesson on the value of systemic trading. The company is a Small-Cap Star, presenting a valuable lesson about constructing a portfolio that can succeed over time.
Famed investor Peter Lynch was always open about the fact that many of his stock picks were duds or worse, stating that picking six in 10 stocks well is enough to be a star fund manager. Taking chances on smaller companies offers chances for much bigger returns, but they also present a greater potential for failure.
This is especially true when discussing the biotechnology industry. In examining small-cap health care stocks, analysts are often presented with a pretty damning task. There’s virtually zero fundamentals that have a great deal of meaning because the company’s valuation rides almost entirely on the success or failure of clinical trials for its developing therapies. There’s no revenue, no earnings, no P/E ratio to work with.
However, developing a consistent system for identifying strong health care companies can still be fruitful. While it’s impossible to anticipate which therapies will return positive clinical results ahead of time, identifying those companies that are best suited to take advantage of success can still result in a solid portfolio. By simply accepting the risks involved and understanding that picking winners necessitates also selected the occasional loser, investors can construct a strategy that should pay off in the long run.
The reason I bring it up is because that’s precisely what the Small-Cap Stars is based around. The list presents enough stocks to absorb a few hits like Arrowhead Research because it’s also producing a number of big winners to counter-balance those losses. Certainly, it may seem odd to base an investment system around something other than the primary motivating factor for the stock’s success, when one cannot predict the outcomes for that specific factor, it doesn’t mean there aren’t other options.
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