How I Evaluate Cancer Stocks

Zachary Hartman  |


What is the best biotech stock to invest in? How do I find the biggest opportunities in cancer research? Should I invest in that cancer penny stock?

These are all questions that enter the minds of new traders, and they continue to hound even veterans. For me, I am most comfortable sticking to a specific area: cancer research. It is where my training is planted. This is the area where I feel like I can gain the best edge over the forces of more money, better trading algorithms, more powerful machinery, and bigger analysts.

As I laid out in my first article, though, it doesn't take a cancer cell biologist to see the rich opportunities in cancer research stocks. Just like all of biotech, oncology has the potential to net major returns. This is an area of pharmaceutical research that cannot go away until there is a cure for every form of the disease.

And I'm sad to say that it may be a battle we as a species never stop fighting. Right now, we're living in a golden age of cancer medicine, though, one full of new wonders every year pushing the standard of care forward. In this article, I want to give you the basic steps I take to avoid the riskiest cancer stocks, while helping you to identify the biggest opportunities.

For anyone, I propose 5 pretty simple steps to move through in evaluating a cancer stock. A lot of companies are very good at creating a lot of excitement for their research, and, to be fair, there are many of these that will end up meeting the hype. In the meantime, you risk becoming deflated as you watch your holdings fade in value from dilution and attrition. So what are the steps I recommend you follow when considering a new investment?

The first step, and arguably one of the most critical, is to take the massive amounts of data floating out in the world and sift it to a manageable density. It is not going to be possible to do in-depth research on all 100+ biotechs with no approved products. You simply won't get much useful information out of this.

Of course, that doesn't mean you should limit your research to a few randomly chosen stocks, either! If you pick a few at random, maybe based on some kind of news you've heard, there's a chance you'll get lucky. However, there's an even bigger chance that you'll fall flat on your face. What's worse is that you're more likely to become emotionally attached to the investment, since it was one of only a few you checked out.

No, the answer is to narrow your search using some kind of criteria. I published an article to this end on Seeking Alpha describing one method to do this. If you care to, you can read that here.

But the method boils down to a few key steps:

First, we need to develop a list of potential investments. For this article, I searched for "list of cancer stocks" in google and pulled out the companies that already have an approved drug. Companies with an approved drug already have a different sort of calculus that you'll need to apply, so this method is specific for companies with basically no revenue or imminent revenue potential. I organized these companies into a spreadsheet (which you can actually find here)

Pull the latest quarterly filings for each company in your list. You're going to use this to find several key pieces of information:

You'll notice that this is a lot of the information I covered in my post about looking at a biotech company's SEC filings. Essentially, while it's important to look at many different factors, we want to quickly arrive at just a few key pieces of information: cash runway and where they are in development.

The essential part of the screen is identifying those companies that are way too far away from an approved drug. If you're going to be sitting around for 5 years waiting for this thing to move, then you're adopting a different mindset more suitable for the very long-term investor. If you're willing to accept the risk of eroding your original investment, feel free to do this. Unfortunately, for many people, they end up taking losses in excess of 90%, and that final approval they hope for might be just enough to break even.

For the purpose of the screen, we need to consider how far the company has to travel, and how much cash they have left. You can roughly approximate how long a drug will take, conservatively, to be approved, based on where it is in trials right now. If the company is in phase 1, then they'll need at least 5 to 7 years, whereas in phase 2, you might be able to count on between 3 and 5 years left. In phase 3, you're starting to reach the home stretch, and a new drug application with the FDA is your final lap, where you're around a year out from approval.

Of course, you can find all kinds of factors that can speed up or slow down drug development. Maybe they get a Breakthrough Therapy designation. Perhaps they show staggeringly good results early on in a high unmet need. Or maybe they hit a wall with bad trial results, or the FDA rejects their drug.

My point? Drug development is hard to predict for individual cases. But if you stick to the time frames I laid out above, you will be well positioned to avoid companies that are going to lose you money in the near or mid term.

So for simplicity's sake, I multiply the quarterly cash burn (the net loss) by the number of quarters it will typically take to get from the phase they're in to approval. if this number is bigger than the total of cash and short-term investments, then this is a company that is more likely to need an infusion of cash.

Remember: if you're dealing with a company with no approved products, you should count on that infusion of cash coming from your investment in the form of dilution. It's possible that they'll find a lucrative partnership to solve cash problems, but you should not count on it! Now, if you're ok with taking a small dilution hit, then you can build some wiggle room into this calculation. However, it is important to remember that burn rates do not usually go down as companies advance further into their development.

Once you have pared your list down to a few companies of interest with what seems like a low risk of diluting you to oblivion, you can begin to undertake a deeper dive. For this, I recommend both scientific and financial due diligence.

First, cash is king, so we need to begin from the cold reality of the SEC filings once more. Now is the time where we'll want to try and model things in a bit more of a sophisticated way. First, we'll take under consideration whether the company of interest is a penny stock, which carries the various risks I outlined in a past article.

Truth be told: I would not outright discount a penny stock in this method. But we need to make sure they're on the up and up. Make sure they have a good standing with the SEC, which means they maintain quarterly filings even if they don't trade on one of the larger exchanges. If the company cannot keep up with these basic financial reporting guidelines, do yourself a favor and move on.

Other than that, we need to go and read more about what the company has to say in its own filing. This will help you get a good handle on where this company is prioritizing its funds, particularly if they have a relatively deep pipeline. For example, many companies will detail what kind of split their research and development is going into. Take Advaxis  (ADXS) as an example here:

Advaxis Quarter One Research and Development First-quarter 2018 breakdown of costs for Advaxis

Right off the bat, you can get a quick sense for where the majority of R&D funding is going: HPV-associated cancers. Advaxis's most clinically advanced drug is called axalimogene filolisbac, and they have a phase 3 trial ongoing for cervical cancer. This gives me a very important idea of how much I should prioritize different programs in the pipeline. Clearly, the company is telling me that the HPV-associated cancers are a big priority.

Moreover, we can see from this kind of chart that the "Prostate cancer" line item has actually decreased from the same time period last year. This suggests that the company is not putting as many resources into this. Same with the neoantigen program. However, in the text of the filing, the company will provide you with some information about why expenses are growing or shrinking. For example:

The quarterly filings are also great sources for summaries of recent news and ongoing developments. Instead of digging through press releases and message boards, you can get an overview of each of the company's main programs. In the case of the Advaxis filing, for example, you can find this passage describing earlier-stage developments:

This summarizes some news that came out via press release. The two big problems with news releases are that they can easily go away as they get older, and rarely will you see them archived well back more than a few years. Second, many companies make it so you have to dig and dig through small events to get to major priorities like this one. Just looking through the news would make it tough to appreciate what's going on here.

Financial filings also give you a sense of how much debt the company has, if you look on their balance sheets, as well as how much expense they're paying as a result of carrying that debt. This can be particularly helpful when evaluating penny stock companies that may have particularly shaky financials. A company with a huge load of debt may be careening toward bankruptcy.

The long and short of step 2 is that you should not ignore the quarterly and annual filings of the company you're interested. You can find a treasure trove of information in these, and you should at least go through and find potentially important pieces of analysis from the company. Definitely read the narrative parts of these filings, as they can summarize several months worth of news and put them in perspective.

You don't necessarily need to read the filings end to end, but if you want to get a sense of the health and priorities of the company, you need to delve into these documents. They'll help you know better whether and how you should proceed with step 3.

In all honesty, you can spend the next ten years trying to learn how to interpret science and place it into the larger context of clinical medicine. But that's not the intention of most investors, who just want to learn enough to try and make a good bet.

I feel for you! Cancer research is a complex ocean of massive clinical data, riddled with jargon that makes it impenetrable to laymen. The first big thing I recommend you get familiar with is your sources. There are at least 5 key sources that you should know about:



Obviously, this is not an exhaustive list of resources, but it gives you plenty of meat to chew on as you move forward in assessing a company's science. I could write an entire article on how to actually use all of these resources, but for now let's just focusing on the one that may intimidate you most: the scientific journal article.

First, the big problem for a lot of people is getting ahold of these articles. In many cases, you can find them published for free on the journal website, particularly if the study is high-profile in nature. For example the PACIFIC study was a very important trial detailing the use of AstraZeneca's durvalumab in lung cancer. As I write this, the article is also freely available for download by anyone in PDF form.

If you're not able to get your hands on the paper, you can always go to Pubmed and search for the title of the research paper in question to gain access to the abstract. This at least lets you know, in one or two sentences, what the intent of the study was. Then, you can get a brief overview of the results and conclusion. It's definitely better than nothing, but if you intend to do a deep dive, you'll need more.

Still, if you're a layman, you may not feel a big need to try and pull the deeper information out of the paper. That's ok, because you can still learn a lot by reading the Introduction, which will provide the background, as well as the Conclusion, which will roll the results into the context of the field at large. This is important, even if it can be challenging! By coming to grips with the field overall, you can get a sense of the competition and the potential market size for the drug, if it has not yet been approved.

For many companies, however, you won't find a lot of published material. In many cases, promising new technologies require a lot more time before they're publication-worthy in the first place. Otherwise, you end up with ambiguous data in a low-impact journal that won't move the needle.

You will, however, find plenty of opportunities to delve into primary research presented at large meetings, such as the American Society of Clinical Oncology and the European Society for Medical Oncology annual meetings. Ideally, you would find the slide decks for these posters and oral presentations. However, if you don't have a membership or access to a membership, this can be hard to come by.

I find that an essential hack here is to use Google and the company's website to see if they have published the presentation themselves. In many cases, you'll find this to be true. Coming back to the Advaxis example, I may want to ind the results of their GOG-0265 study, which I saw from reading the filing was the basis for their submission of axalimogene filolisbac to the European Medicines Association for approval.

But the SGO website is basically useless for finding specific abstracts, let alone presentations. So I ran a Google search for "GOG-0265 results" and then added "PDF" to the results, which is how many of these are published in downloadable form. Lo and behold!

Advaxis axalimogene filolisbac looking for answers Google search for GOG-0265 study results

The first result in this case led me to some part of Advaxis's website that would be difficult to find by navigation alone, unless the company is very diligent about posting these presentations and publicizing them (hint: many are NOT). Using this, I have been able to find a lot of hard-to-get data presentations from congresses.

Abstracts offer you a look into the big pieces of data. However, they are also more often than not "interim" analyses. These are done before the study has officially been completed. Rarely are they definitive. But still, having some data to look at is better than no data!

In total, you simply must get at least a little comfortable with reading science material. The more you do it, the more you'll get comfortable. You can always seek advice from other shareholders or people you trust, as well. But seeing the data for yourself is the best way to make a surefire investment in a company.

After assessment of the science, which can easily take you days of proper due diligence, you need to start thinking of nuts and bolts strategy for your investment. Here, I usually want to answer some key questions for myself, based on my analysis.

That last question, in particular, gets a lot of biotech investors in trouble. It's too easy to get caught up in the hype of a stock and chase the rise in share price, only for the inevitable downturn to begin not even 10 minutes after you buy. How many people do you know who feel like the best bet you can make is to buy when they sell, and sell when they buy, because they feel jinxed? It's due, in part, to bad timing from the outset.

So you need to stand back and plan your shot before taking it. There's no one great trick for this, other than to breathe and take a longer look than you're comfortable with.

If you're used to buying within ten minutes, then watch the stock for a whole day without buying. Then, look for the stock to stabilize toward some kind of baseline and start buying in. As you can see, there's no tried and true process, no matter what the technical analysis wizards claim. You can't really look for crossing averages or other signs for a perfect buy signal. However, if you exercise patience and always believe that a good buying opportunity will come, you will be right far more often than you are wrong.

With that in mind...

If you're going to be successful in biotech investing, in general, and cancer research in particular, you need to have a plan for how to take advantage of inevitable moves the stock will make. Some days, you're going to see inexplicable dips, what the shareholders will dub "manipulation." Will you sell? At what point do you throw in the towel?

On the opposite end, some days you will get favorable news from the company, and the jet fuel seems to ignite. At what point will you take something off the table?

This article is not designed to help you set your goals, only to advocate that you DO set goals in your trading. Even if you're a diehard long investor, you should have some kind of plan that you are comfortable sticking to. Every biotech investor I know has been burned at some point by a huge lucky play that they decided to ride out, thinking that nothing could cause the stock to lose momentum and come back down to earth.

Too many times, that's exactly what happens. You'll be sitting at $2, watch it head for $14, and then watch your precious gains dwindle away over the course of years. And you'll forever regret the opportunity you never took. This whole concept is the subject of my book on stock market strategy, The No BS Plan. But this article is not intended as an advertisement, overall.

The long and short of this is I cannot set your goals for you. That's definitely in your court. However, the biggest favor you can do for yourself is to set some kind of benchmarking for your holdings. Something like if you gain 50%, that you'll sell off enough to be positive no matter what else the company does.

Even more importantly, you need to set aside your ego and place a price for selling out. What are you wiling to tolerate? If its a 15% loss, then stick to it. If you've done this much work researching a stock, you might have become a true believer, and you won't see any reason for it to be in the red at all, let alone going down more than 15%.

But your mantra for taking losses should be this: "It's going down. There's lots of room for it to go down more." If you assume it will go down, then the pain of loss is done. If you're terrified of missing out on a gain, then sell down in blocks. Something like promising yourself that if it reaches 15% loss, then you'll sell off a quarter of your holding, and then if it holds those losses the next day, you sell the next quarter of your holding.

You must put your ego aside here and learn to admit when you might be wrong. Otherwise, you're going to end up as one of those bag holders taking 85% losses over the course of years as the rest of the biotech market seems to be going to the moon.

Investing in cancer research can be exciting and terrifying, just as it can be incredibly risky and rewarding. If you take the mentality of a sniper, where you set up your camp, sit for days or weeks learning about the target, and then finally pull the trigger, you'll find where the real work should lay. It should be in your prepwork for investing, as opposed to watching the stock charts and losing sleep once you're committed.

If you can follow these steps with discipline, you will be able to position yourself to get luckier more often when looking for the winners in this market.

Note: This article was originally published on my blog Invest Against Cancer.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
ADXS Advaxis Inc. 1.48 0.03 2.07 533,710 Trade

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