The prospects of new funding and scientific advancement have rekindled investor interest in the volatile and controversial stem-cell research sector, especially the top players.

Since the Bush administration put limits on federal funding for embryonic stem-cell research in 2001, any public support has come on the state level.

On the scientific front, recent progress in manipulating and multiplying stem cells that could reverse damage to nerves, muscles and vital organs boosted the industry's reputation.

Despite the positive developments, the dynamic and complex field of stem-cell research remains somewhat misunderstood by politicians, consumers and investors alike, and it has yet to attract much analyst coverage.

"No analyst has put a stake in the ground claiming the field," says David Greenwood, chief financial officer of

Geron

(GERN) - Get Report

, a company with 250 patents in embryonic stem-cell research. "I would be surprised if anyone does that in 2005. ... Analysts are waiting to see if someone can move the science into technology, meaning product development, and manage to get a product into and through the Food and Drug Administration and into clinical trials that show both safety and efficacy. I don't think, until that time, there will be a large following from Wall Street analysts -- sell side or buy side."

States' Rights

A number of states have taken up legislation funding stem cell research -- including the politically sensitive area of embryonic stem cell research.

In late March, a bill promoting stem-cell research was passed by both houses of the Massachusetts legislature by margins that could override a veto from Gov. Mitt Romney. He said he would "vote my conscience" and veto the legislation on moral grounds.

In November, California voters approved Proposition 71, which devotes $3 billion over 10 years to fund stem-cell research and establishes the California Institute for Regenerative Medicine.

The New Jersey legislature has passed a bill encouraging state scientists to do stem-cell research, and then-Gov. James McGreevey, a Democrat, increased funding to the Stem Cell Institute of New Jersey.

New York State is also considering funding of stem-cell research. In the Senate, pending legislation proposes a $1 billion investment over a decade. In the Assembly, a recently introduced bill calls for $300 million in state funding for stem-cell research over a two-year period.

Shares of

StemCells

(STEM)

and

Aastrom Biosciences

(ASTM)

, two companies that use adult-derived stem cells, jumped more than 15% on the New York news last month. Shares of Geron added 7%.

The three companies have market caps between $200 million and $320 million, with Geron at the top. Aastrom is the clear leader in trading volume, with some 14.5 million shares changing hands each day. StemCells and Aastrom are trading around the midpoint of their 52-week ranges, while Geron is close to its low.

StemCells is developing treatments for central nervous-system diseases. Aastrom Biosciences, along with selling products used by researchers in developing cancer vaccines, is involved in four ongoing Phase II clinical trials using stem cells for bone regrowth. Geron, which in 1999 was the first company to use human embryonic stem cells, is developing neural cells for spinal cord injuries and Parkinson's disease, using its patented technologies to isolate the cells.

The industry also benefited from new attention last June because of the death of former President Ronald Reagan, after a long bout with Alzheimer's disease. The event revived a debate that came to the fore in the months leading up to George W. Bush's first term as president, when Nancy and Ronald Jr., the wife and son of the former president, lobbied for federal funding of research using embryonic stem cells to develop treatments for diseases like Alzheimer's. The death of actor Christopher Reeve also refocused attention on the treatment potential of stem cells for spinal cord damage and paralysis.

A Tough Cell

Since the sector is relatively new and very volatile, analysts have yet to really cover it. What's more, there's reason to think investors don't fully understand the sector or the business models of the individual players. For example, the whole sector jumped on news of increased public funding for embryonic stem-cell research -- but several companies that benefited don't even use stem cells taken from human embryos.

Embryonic stem cells are harvested from days-old fertilized human eggs. Cells can also be harvested from nasal passages, bone marrow, muscle tissue and fat, but such adult stem cells were widely believed to only produce cells of the particular tissue type from which the cells are extracted. Thus, embryonic stem cells were seen as a more hopeful option because, unlike other cells, they can develop into a range of cell types such as those of the liver, pancreas and brain.

"The only benefit of embryonic stem cells is convenience," says Stephen Dunn, who covers life sciences at Dawson James Securities. California voters -- the majority of whom are Democrats -- approved Proposition 71 "just to thumb their noses at Washington," he says. "Now all the researchers will go to embryonic stem cells, which is where all the money is, even though, with most medical conditions that can be cured, adult stem cells are adequate."

In what may be a reflection of the volatile and dynamic nature of the sector, Dunn has changed his rating of the volatile Aastrom Biosciences shares three times since January. (Dawson James is currently seeking an investment banking relationship with Aastrom Biosciences.)

Recent research has fueled hope that adult-derived stem cells might have the same generative capacity as embryonic ones.

In early April, researchers at Indiana University announced they had transformed bone-marrow stem cells into sensory-nerve cells found in the ear. Dr. Eri Hashino and her research group extracted marrow-stromal cells, which normally develop into fat, bone and cartilage, and changed them into cells with genes and proteins specific to auditory neurons.

Last month, a study conducted at Australia's Griffith University stunned the industry with news that nasal stem cells can grow into any kind of cell in the body, just as embryonic, so-called "pluripotent," stem cells can. The use of one's own stem cells reduces that risk of rejection by the immune system, and the ability to develop varied cell types from nasal stem cells could eliminate the need for embryonic cells.

"There have been cases in the past three or four years where adult-derived stem cells give rise to cells with characteristics of different cell types," says Geron CFO David Greenwood, "but those could be the result of cell mutation or the creation of a hybrid cell." Until he sees more evidence of cell transdifferentiation, Greenwood doesn't believe these findings affect his company's business, which focuses solely on embryonic stem cells.

Aside from Geron, StemCells and Aastrom BioSciences, most of the players in the budding industry have minuscule market caps. Most have no products or patents -- or even trials or treatments. Some are traded over the counter.

Big or small, well-known or obscure, the fate of these still-growing companies depends on government funding motivated by faith in science and the hope of finding cures for debilitating and fatal diseases.

As originally published, this story contained an error. Please see

Corrections and Clarifications.