Stock Watch: Tales Of Stock Price Overreactions

Investors often overreact to both good and bad news. Positive clinical trial results can be welcomed with ballooning stock prices that incorporate blockbuster sales expectations, very little marketing cost offset and 100% probabilities of regulatory and commercial success. The converse is also true. The market capitalization of a biotech company with a single clinical asset can fall below the value of its cash after a Phase III failure or, as in the recent case of gene editing company Graphite Bio, Inc., a clinical hold after dosing the first patient. This second type of overreaction is more logical because investors are inferring that the company needs to spend a good chunk of its cash to come up with something else of value.

While accountants may point to stock prices reflecting the value of companies’ assets before any of them have been utilized to develop new products, investors probably have a more realistic and sanguine approach to distressed biotech company valuations. My first boss in fund management used to say that even after a complete failure there would always be something of value left in a biotech company, such as the patents, lab equipment or even manufacturing facilities