Sweet Spot in Biotech Investing

For example, MannKind (MNKD) has seen its stock rise and fall sharply several times. Investors got their hopes up on the company's inhaled insulin product Afrezza, only to see the FDA reject it time and again over safety issues.

This is one reason why Phase II is the real sweet spot for biotech investing.

Phase II is often the most profitable time to be involved in a small cap biotech stock. Many times, Phase II results are positive. Sometimes it's because the drug works. And other times it's because the trial is rigged to provide positive results.

For example, Cel-Sci (CVM), a company that stirs passion (both positive and negative) among biotech investors, ran a Phase II study on the head and neck cancer drug Multikine. However, rather than test the drug against other existing treatments, Multikine was given along with an existing treatment.

At the end of the trial, Cel-Sci boasted of a 12 percent complete response rate. But it was impossible to determine if the two out of 19 patients who had a complete response saw their tumors disappear due to Multikine or due to the other treatment.

So, why would a company do that?

To show good results in the hopes of raising additional capital.

There are also times when the science is conducted properly and Phase II claims are valid, but the drug isn't able to replicate results in a Phase III trial. Remember, a Phase II trial usually contains a much smaller sample size, which can easily distort results.

Very often, when a company reports strong Phase II results, the stock takes off as it is the first real indication that it might be approvable. Investors get excited; potential partners begin sniffing around; and the media begins to cover the drug's potential. Even though at this point things are just starting to get promising, it's often a great time to take the money and run.

Phase III, on the other hand, is fraught with risk. These trials are expensive to run, and there's no guarantee that the drug will again show strong results. For example, there have been some instances where the drug replicated its earlier results, but there was a stronger-than-expected response from the placebo group, narrowing the difference that the drug made and making it appear less effective.

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