When successful, penny stocks can be game changers. Tiny companies can explode into industry leaders, sending their stock prices through the roof and make their shareholders very rich. Sadly, such explosive potential also comes with potentially devastating risks.
So far, Avacta (LSE:AVCT) shareholders have enjoyed and endured both sides. Those who invested in this biotech business in 2019 are probably celebrating, given the 250% return. Yet those who hopped on the train in mid-2021 are likely questioning everything, given shares are down almost 75%.
It’s a similar story for those who became shareholders at the start of 2024 since shares have tumbled almost 40%. So what’s going on? And is now the time to start buying?
Volatility of biotech
As a quick reminder, Avacta’s an upcoming diagnostics and cancer therapy specialist. It gained a lot of attention during the pandemic thanks to its lateral flow test kits for Covid-19. But, since the demand for this product has waned significantly following the rollout of vaccines, sales growth has slowed and profitability’s evaporated.
Consequently, investor patience is seemingly running thin. Even more so given the troubles management encountered in receiving regulatory approval for other testing kits in 2023.
This pattern isn’t uncommon for young biotech businesses. Valuations are often driven by expectations. And failing to meet targets can be devastating, especially for small-cap and penny stocks. But is there hope?
Focusing on the long run
As previously mentioned, diagnostics is only one half of this enterprise. The other is cancer therapy. And on that front Avacta’s making encouraging progress.
Following a recent update, Phase 1 clinical trials for its AVA6000 drug have sucessfully completed the second cohort, with the third now underway. That puts the company on track to hit its clinical trial objectives for 2024. And given Phase 1’s where most treatments fail, these positive results are a very encouraging sign.
To help speed things along, the company’s appointed a new scientific advisory board of cancer experts across the US and UK. And with around £35m of cash on the balance sheet, Avacta should have enough capital to complete Phase 1 trials.
Yet, as exciting as this news is, there remains a long journey ahead. There are still two more clinical trial phases to go before reaching the market, each significantly more expensive than the last. And £35m isn’t going to cut it. As such, I wouldn’t be surprised to see large volumes of shareholder dilution moving forward.
But even if it can raise all the necessary funds, that doesn’t guarantee future trials will be a success. Don’t forget over 90% of clinical trials fail.
A risky buying opportunity?
It goes without saying that Avacta’s an incredibly risky investment. Even though its market-cap currently sits outside of penny stock territory at £260m, it seems to be held up almost entirely by expectations of clinical success. After all, shares are currently trading near a price-to-sales ratio of 10.
In other words, even with shares taking a big tumble, they’re still quite expensive. However, should AVA6000 be a success, today’s price may be worth paying. Nevertheless, given that it’s going to be years before AVA6000 will be contributing to sales, assuming it’s successful, this stock seems to me like a massive gamble compared to other opportunities right now. I’m not buying.
This post was originally published on Motley Fool
