If You Bet Big on Clinical-Stage Biotech Stocks, Don't Be Surprised if This Happens

Source: ImmunoGen.

Biotech stocks, taken as a whole, have absolutely crushed the market over the trailing five-year period. Sometimes it almost feels as if you could throw a dart at a collection of biotech companies and land a winner.

But there's a grim reality that biotech investors sometimes have to face: most clinical trials fail to achieve their goals, and stocks can go down just as easily as they can go up. Last night, shareholders in two clinical-stage biotech companies learned this the hard way when their respective companies reported top-line mid- or late-stage results that missed their marks. Not surprisingly, both paid the price in a big way.Clinical de-Flexion Small-cap biotech Flexion Therapeutics ended the after-hours trading session down better than $11 per share, or 38%, following the release of top-line data from its phase 2b study involving FX006 for the treatment of moderate-to-severe osteoarthritis knee pain.

Source: Centers for Disease Control and Prevention.

On paper, FX006, a sustained release steroid, looked like a winner. An aging population that's living longer than ever could certainly benefit from a drug designed to treat osteoarthritic knee pain. However, what's on paper didn't exactly translate into real-world results for Flexion (at least not yet). Although its therapy provided "substantial and persistent pain relief" compared to the placebo, it did not meet the primary endpoint, which was a sensitivity analysis conducted at week 12.

As noted in Flexion's press release, the 40 mg dose handily outperformed the 20 mg dose, and it demonstrated statistically significant results in terms of average pain relief from weeks one through 24. FX006 was also well-tolerated by patients. Flexion, after reviewing the data, plans to proceed with a pivotal phase 3 development of FX006, and it will meet with the Food and Drug Administration to discuss the endpoint protocols. It's not impossible for FX006 to succeed after missing its primary endpoint, but to move into a later-stage study and succeed after missing the common mark in midstage studies would be quite unexpected.

A disaster du jour However, the disaster du jour goes to Tetraphase Pharmaceuticals , which ended the after-hours trading session down a whopping 79% (it had been down 82% at one point). The absolute lambasting Tetraphase took in after-hours stems from a primary endpoint miss in its phase 3 IGNITE2 study for eravacycline.

Source: Centers for Disease Control and Prevention.

IGNITE2, which was testing eravacycline as a treatment for complicated urinary tract infections, failed to reach a level of non-inferiority to the generic medicine it was pitted against, levofloxacin. Patients were given three days of intravenous therapy and transitioned to oral therapy after that. Tetraphase's therapy met neither the U.S. nor EU outcomes in terms of non-inferiority to the placebo.

Tetraphase's management plans to further analyze the data to determine if there's a path for eravacycline to move forward as a treatment of complicated urinary tract infections, but the drubbing the stock took in after-hours trading would suggest that its future as a treatment for cUTI is nonexistent.

It is worth noting that Tetraphase's phase 3 study of complicated intra-abdominal infections in the IGNITE1 study did hit its primary endpoint, so Tetraphase still has something potentially positive to look forward to from eravacycline, even if cUTI would have been a bigger indication.

Lessons learnedLast night's throttling of these two former biotech darlings serves a number of purposes.

First, as discussed above, it's a solid reminder that stock markets move in both directions. Even with emotions and future sales projections playing a big role in determining biotech stock valuation, there still has to be some justification for a biotech company's valuation if it's to stick. Based on last night's drubbing, the implication is that both companies may have been more than fully valued from the get-go. The point being that you still need to dig deep into the biotech sector if you hope to land a winner. The "throw a dart" approach just isn't a smart bet.

Secondly, if you bet on wholly clinical-stage drug developers, you had better try to find a few that have diversified pipelines. Tetraphase's reliance on eravacycline, and Flexion's pipeline -- which is just three experimental therapies deep (of which one is still in preclinical trials) -- leave investors open to wild swings lower if things don't work out.

Source: Isis Pharmaceuticals.

However, you don't have to buy a giant pharmaceutical company to get diversification. Biotech mid-cap Isis Pharmaceuticalshas two approved therapies on pharmacy shelves and 27 ongoing clinical trials, while cancer drug developer ImmunoGenhas one FDA-approved therapy and 13 compounds currently in clinical testing.Each of these trials and compounds represents an opportunity to hit a home run, and the more "pitches" a company can see, the better its chances. If you look around the sector, you can find diversified development pipelines that can reduce your chance of being caught on the wrong end of a 40% or 80% move lower.

Lastly, it's a strong reminder that investors are often best served buying established companies that are profitable and have developed pipelines. The downside of buying a company that's already on Wall Street's map is that you've "missed the big pop." But more often than not you have a much better chance of profiting over the long run (and being right more often) if you stick to the sidelines until previously unproven biotech companies demonstrate their worth. The amount you can make from long-term profit growth, deals and collaborations, and possible dividends will usually outweigh the "pop" you might get when a clinical-stage company reports its mid- and late-stage results.

I certainly can't stop anyone from investing in clinical-stage biotech stocks -- and there will definitely be winners among the bunch -- but be well aware that what happened to Tetraphase and Flexion last night could just as easily happen to you if you're willing to roll the dice with clinical-stage biotech stocks.

The article If You Bet Big on Clinical-Stage Biotech Stocks, Don't Be Surprised if This Happens originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool recommends ImmunoGen and Isis Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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