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Half-Wit Bureaucrats Serve Up a No-Brainer Biotech TradeBy Dr. George HuangFriday, November 27, 2009 I'm a volatility junkie. I admit it. Hundreds of percent, one-day stock moves get my heart racing. And only one sector in the market continually provides my fix: biotech.
Of course, the reason biotech traders enjoy such massive stock moves is the U.S. government, specifically, the Food and Drug Administration (FDA).
Last month, I outlined five upcoming FDA decisions that should have ignited fireworks. But for the most part, the pyrotechnics didn't happen. FDA bureaucrats decided to postpone the show until the first quarter of 2010.
The agency did make one decision that could lead to a huge trade. But before I get there, let me back up a bit...
Every prescription drug needs to win the FDA's approval before landing on pharmacy shelves. Securing that approval isn't the most difficult part of the decade-long process of bringing a new drug to the market. But it's certainly the most visible.
A rejection can send a stock tumbling as much as 90% in a single day. And positive news, particularly when it's "unexpected," can send stocks soaring as high as 1,000%.
That kind of volatility can make speculators a fortune. But trading prior to an FDA decision has become a very difficult way to make a living...
Drugmakers pay an average $1.4 million for the privilege of submitting their data to a bunch of government half-wits. In exchange, the FDA accepts the legal obligation to review the drug in a timely manner. Unfortunately, the FDA has a bad habit of missing its own deadlines.
For example, the FDA pushed back three of the five decisions I previewed last month. Xenoport, Cadence, and Acorda all received three-month delays... and they got off easy. The agency missed deadlines for drugs by Auxilium and Novo Nordisk without providing any timetable for a decision. (I guess $1.4 million just doesn't buy you many government favors these days.)
Missed deadlines can destroy trades aiming to profit from a big stock move. So, as I've written before, I prefer to wait for an FDA decision before jumping in. One of my favorite trades is to watch an FDA rejection crush a quality stock... and then scoop up shares at a discount. A 10-year back study showed this strategy can return up to 50% annually.
One of the decisions I pointed out last month may be shaping up as a big opportunity. The FDA rejected (on time!) biotech behemoth Amgen's osteoporosis drug, a potential blockbuster called Prolia. Amgen's stock took a 15% dive to $52 before stabilizing around $55 per share.
At $50, Amgen would be trading for less than 10 times free cash flow. Even now, the stock is cheap. I expect Prolia to win approval late next year, which should send shares above $60.
I thought the setback would give us a golden chance to catch Amgen below $50. It hasn't happened... yet. But I think the rejection plus even a small market correction could send the stock to our target. At that level, we can make a conservative 20%-30% return on a no-brainer trade.
Good investing,
George Huang
Further Reading:
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