Small Cap Stocks to Watch in Biotech

Although their tiny size makes them inherently riskier, small cap stocks hold an incredible allure for investors due to a common misconception that a smaller stock has a better chance of doubling in value than a higher-priced stock. Even though there's no merit to this myth and many small caps will end up losing to the market, these stocks remain a big draw for traders. But, if you're smart about picking only the most promising small cap stocks, you can actually end up with big returns. Personally, I find the biotech industry to be an intriguing place to go hunting for great small cap stocks.

With that in mind,today we'll take a closer look at three small cap stocks to watch in the biotech industry. I want to make itcrystal clearthat I'm in no way recommending these stocks for purchase (remember, small cap stocks carry above-average risk), but I am suggesting you add these small cap stocks to your watchlist for further review. These companies all have a market cap under $1 billion and share prices under $5, but, importantly, you can still find them on reputable exchanges.

Source: Flickr user David Goehring.

Peregrine Pharmaceuticals The first small cap stock to watch is cancer immunotherapy vaccine developer Peregrine Pharmaceuticals, which is currently sporting a valuation of around a quarter of a billion dollars and a stock price of a little over $1 per share. With no approved products on pharmacy shelves, those metrics alone are enough to scare away most investors.

However, there could be some significant value here if the company's phosphatidylserine (PS)-targeting technology actually pays off. Under normal circumstances, PS receptors are located on the inside of a cell, acting as an immunosuppressant that protects a cell from destruction by the immune system. In cancer cells PS receptor location is reversed; they're found instead on the outside of the cell. This causes the immune system to overlook these cells, allowing them to proliferate.

Source: Peregrine Pharmaceuticals.

Peregine's lead product is bavituximab, a PS-targeting monoclonal antibody that interrupts this immunosuppressant quality of cancer cells and enhances the body's ability to fight cancer. Bavituximab is currently being tested in a late-stage study known as SUNRISE as a second-line therapy for non-small cell lung cancer. In mid-stage studies it hit the mark with a median overall survival of 11.7 months compared to the control group's median overall survival of just 7.3 months.

Peregrine does generate some revenue from its contract manufacturing subsidiary Avid Bioservices, but make no mistake about it -- Peregrine's valuation revolves almost entirely around bavituximab and the potential for Peregrine's PS-targeting vaccines to crush cancer. SUNRISE is going to go a long way towards validating Peregrine's platform, and investors should have a measure of its efficacy by as soon as late 2016 or early 2017.

Galena Biopharma Among small cap stocks to watch in biotech, perhaps none offers a higher risk, or higher reward potential, than Galena Biopharma, a roughly $300 million company with a $2 per-share stock.

Galena is very similar to Peregrine in that it focuses on developing cancer immunotherapy vaccines, although its focus is primarily as an adjuvant therapy to prevent the recurrence of cancer after treatment.

Galena's lead product is NeuVax, a vaccine currently being tested in phase 3 trials known as PRESENT to evaluate its ability to prevent the recurrence of breast cancer in patients with low-to-moderate HER2-expression. A full NeuVax treatment consists of just 11 vaccines total over a three-year timeframe, so it would be a nice victory in terms of patient quality of care. In a five-year midstage study NeuVax helped lead to a statistically significant 78% reduction in terms of breast cancer recurrence for the low-to-moderate HER2-expression subgroup relative to the placebo vaccine.

Source: Galena Biopharma.

Galena also has other promising vaccines and compounds in its pipeline beyond NeuVax, including GALE-301 to prevent the recurrence of ovarian and endometrial cancers, and GALE-401, an anagrelide controlled-release drug designed to treat patients with thrombocytosis secondary to essential thrombocythemia and other myeloproliferative neoplasms. Both GALE-301 and GALE-401 followed in NeuVax's footsteps by demonstrating strong early efficacy, with 78% of GALE-401 intent-to-treat patients experiencing a platelet response, and GALE-301 patients receiving the 1,000 mcg dose seeing a 78% reduction in relative risk of ovarian and endometrial cancer recurrence compared to the placebo.

Galena is far from lacking risks, however. Galena has a somewhat shaky cash situation -- it's currently losing money, and the PRESENT trial isn't slated to be over before 2018. Additionally, Galena's CEO role recently saw a shake-up, which hasn't sat well with investors. Still, if NeuVax finds the mark in phase 3 studies, Galena could deliver substantial returns to shareholders.

Exelixis The final small cap stock to watch in biotech, which is threatening to break out small cap territory within a few months, is Exelixis.

To be frank, I do own shares of Exelixis, so understand that my enthusiasm regarding the stock will likely be a bit biased and you'll obviously want to take a deeper dive than what I'm offering you here.

Keeping with the theme, Exelixis' focus is on treating cancer, although it isn't an immunotherapy drug developer like Peregrine or Galena. Exelixis currently has one drug approved by the Food and Drug Administration, Cometriq, to treat a rare form of aggressive thyroid cancer. Unfortunately, this one approval is far from enough to pay the bills, so to speak, and Exelixis is going to need to expand its label for Cometriq if it's to be a profitable drug.

Source: Food and Drug Administration via Facebook.

In the COMET-1 study Cometriq missed the mark of statistically significant improvement in median overall survival over the placebo, and shareholders like me paid the price. However, hope is high that in the phase 3 METEOR study (data for which should be out any time now) for advanced renal cell carcinoma Cometriq will meet its primary endpoint of statistically significant improvement in progression-free survival, or PFS. In previous studies (even those where Cometriq failed to meet its overall survival endpoint) Cometriq hit the mark in terms of PFS, so I'm hopeful this METEOR trial will succeed.

In addition, experimental drug cobimetinib is being reviewed by the FDA in combination with Genentech's Zelboraf as a treatment for BRAF V600 mutation-positive metastatic melanoma. The FDA is expected to issue its PDUFA decision on or before Aug. 11, 2015, and things are looking good here as well, with the combo meeting its primary endpoint in the late-stage coBRIM trial.

Like Galena, Exelixis' biggest concern could be its need to raise additional financing, which is something investors will want to take into account. However, as a shareholder I clearly see catalysts on the short- and long-term horizon that could push Exelixis well beyond its current valuation.

The article Small Cap Stocks to Watch in Biotech originally appeared on Fool.com.

Sean Williamsowns shares of Exelixis, but has no material interest in any other 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 owns shares of, and recommends Apple. It also recommends Exelixis. 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.