Thursday, August 7, 2008

Drug Companies Play by Different Rules

I have found that one of the hardest things to do in the financial markets is to trade drug/biotech companies. I always like to play the markets based upon my perception of the underlying market psychology, but the problem with the drug/biotech companies is that they mostly trade upon hype about new drugs and clinical trials. This hype can be immediately killed by one negative trial result or one adverse FDA decision.

The problem with this is that it is virtually impossible to predict for anyone and, on the surface, doesn't that just mean that investors are just rampantly guessing and gambling when they put money into these stocks?

Everytime I have tried to apply my market psychology rationale to biotech companies, I have failed miserably. Initially I came to the conclusion that market psychology could not be applied to these biotech companies, but after careful consideration I now believe that market psychology may in fact be the most important factor in determining how the market prices the biotech companies.

My previous folly in attempting to trade these companies was that I tried to trade them hoping for a positive decision from the FDA or for a positive clinical trial outcome. In doing this, I now realize that I might as well have been playing blackjack in a casino because my odds were about the same. My decision was to never play the drug/biotech companies again in anticipation of an announcement, but that's not to say that I don't plan on playing them at all.

The drug/biotech companies are very much catalyst driven companies (those catalysts being clinical trial results and FDA decisions). However, it is the periods in between catalysts that the human aspect of the market, the market psychology, dictates the movements of these companies share prices.

While there are several companies that I look at regularly in this sector, there is one that continually attracts me, that is Myriad Genetics (MYGN).

I was actually attracted to Myriad initially because of the promise that their Alzheimer's drug Flurizan showed. Unfortunately, Flurizan was recently shown to have produced no effect on Alzheimer's patients abilities to complete tasks of daily life. This was a major setback for Myriad, but the stock price is has not really reflected this setback as one would expect. In fact, this stock appears to have a great deal of momentum which has Myriad near their 52 week high.

With Myriad currently in one of their in between catalyst stages, the question becomes "what will the market do with this stock price?". This is where an understanding of the market psychology can attempt to predict what the near term holds for Myriad.

From here, Myriad will either keep the momentum that it has had for most of this year or it will lose that momentum and suffer a significant collapse in share price. So, which of these two possibilities is more likely given all of the facts?

Myriad does have a solid balance sheet, with a high level of cash that has increased thus far in 2008 and a very low level of liabilities with absolutely no long term debt. This is a very positive sign for a company that relies so heavily on research and development of drugs that may not produce a revenue for years to come and sometimes never.

Working further to Myriad's advantage is the fact they have a diversified portfolio of drugs that are currently under development and testing. The cancer drug Azixa (currently in phase II trials) is likely their most promising drug, but it is still nowhere near production. Further down the pipeline are drugs for HIV/AIDS and Thrombosis, which are currently in phase I trials.

Myriad does have a fairly solid stream of revenues from their current royalties. Though they are projected to have a loss for the upcoming quarter and for the year 2008, their revenue stream is very strong especially when compared to some of their peer companies.

One possible issue that I see for Myriad based solely upon my knowledge of market psychology is that their stock price is very close to their 52 week high. The 52 week high can be a significant psychological resistance level and may pose a significant threat to the stock's momentum especially in light of the recent failure of the drug Flurizan.

So, what conclusion have I arrived at for Myriad Genetics and why is it that I cannot seem to ignore this company?

I think I am attracted to Myriad because they have a solid base of cash with few liabilities and such a tremendous long term upside. While I think that Myriad is due for a share price correction that will likely see them touch 60 a share, I believe that after that the market will give Myriad its momentum back and will see it break through the 52 week high.

This is based upon a careful study of the market psychology and particularly upon the option market open interest levels which heavily favor the call side of Myriad. In my observations, I have seen that the market has a difficult time abandoning a company that has had such strong momentum for such a long time and that is why I think that the market will come around to Myriad again soon.

This strategy is not without risk, but I think catching the surging momentum train that will return after a slight correction will be give traders a chance to make some quick money.

The bottom line is that deciding which way to play a biotech company can be a mind-numbing prospect and is one of the most stressful prospects in all of the financial markets in my opinion. If I listened to conventional wisdom I would probably stay away from the biotech companies that I have lost so much money on in the past, but I like the challenge. That challenge is what I find so exhillerating.
(Disclosure: none)
Happy Trading


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