For the next neuroscience breakthroughs, look to smaller biotech companies

Graig Suvannavejh, PhD
Graig Suvannavejh, PhD Senior Biopharmaceuticals and Biotechnology Equity Research Analyst
August 23, 2022

Imagine if we had a truly effective drug to treat Alzheimer’s disease. For the 50 million people worldwide who suffer from Alzheimer’s and other forms of dementia, the benefits cannot be overestimated. And what if we dreamed bigger and found a cure for Parkinson’s disease and Amyotrophic Lateral Sclerosis (ALS), or other neurodegenerative diseases for which there are currently no effective treatments? 

The incredible complexity of the human brain has rendered treatments for central nervous system (CNS) disorders elusive. But an emerging group of small- and mid-cap (SMID) biotech companies are working on novel drug therapies that may finally deliver meaningful improvements. 

Targeting unmet medical needs

Drug development for neurodegenerative and psychiatric diseases is one of the most exciting areas in biotech, in part because of the number of emerging companies now pursuing this, but also because of the size of the commercial opportunity. Neurological diseases cost the United States an estimated $800 billion per year, and existing treatments rarely deliver significant reduction or reversal of symptoms. 

Thanks to advances in our understanding of how the brain works, innovative companies are now exploring a host of novel treatments. Companies are also testing new drug modalities like gene therapy, cell therapy, and the emerging field of immuno-neurology harnesses the immune system to fight neurodegenerative diseases in the quest for breakthrough treatments. 

Failure rates for CNS drugs have historically been relatively high, and biotech stocks face macroeconomic headwinds such as rising interest rates and market volatility. But there is opportunity to be had. That’s why we believe astute stock selection is paramount for biotech investors. 

Key issues to examine with SMID biotech stocks

When analyzing companies, one of the first things we examine is the basic biology behind the drugs in development. Taking the scientist’s perspective, we feel more confident in approaches based on direct neurological targets rather than approaches that pursue a more uncertain pathway. 

We look at the data. We want to see if results from early-stage human trials or even pre-clinical trials, are strong enough to validate the basic thesis behind the treatment. 

The strength of the company’s management team is another critical factor. We prefer leadership teams with track records of commercializing drugs, as well as experience in the clinical areas they are targeting.

Finally, we look at who is backing these companies. Having a large base of sophisticated, institutional biotech investors and partnerships with larger pharmaceutical firms may provide another degree of validation for emerging therapies. 

Stocks for a range of investor profiles

We used the criteria outlined above to select the six SMID biotech stocks we now cover, but we also wanted to highlight opportunities that would appeal to different types of investors, so we curated a list of companies on a spectrum of potential risk and opportunity. 

On the more established end of that spectrum, we favor Intra-Cellular Therapies (ITCI) and Harmony Biosciences (HRMY). Both are commercial stage companies that have products on the market with blockbuster potential that are still very early in their life cycles. ITCI markets Caplyta for schizophrenia and bipolar depression, the latter which we view as the materially more meaningful revenue opportunity given few treatment options. HRMY, a company that is already profitable, markets Wakix, a novel treatment for narcolepsy, an orphan disease affecting an estimated 160,000 patients. In our view, Wakix faces no meaningful competition and has revenue expansion potential in other orphan sleep disorders including idiopathic hypersomnia (IH), a condition potentially as common as narcolepsy for which there is only one FDA-approved treatment. Currently, HRMY is evaluating Wakix in a pivotal Phase 3 study in IH for which top-line data is expected in 2024.

On the other end of that spectrum, we favor Alector Inc. (ALEC). The company is a pioneer in the immuno-neurology space and its lead asset, latozinemab, is currently in a Phase 3 trial for frontotemporal dementia, an orphan neurological disease for which there are no approved treatments. ALEC has other assets in early-stage trials for Alzheimer’s disease in partnership with AbbVie (ABBV) and GlaxoSmithKline, two blue-chip, global pharmaceutical companies. While the risks are higher with ALEC, so too are the potential rewards, in our view. If proven effective, immuno-neurology could achieve results similar to what we have seen in immuno-oncology, which produced blockbuster drugs like Merck’s (MRK) Keytruda. First approved eight years ago, Keytruda is now one of best-selling drugs in the world. 

Invest in biotech for the long-term

Even though we are excited about the potential in the neuro space, we believe volatility will remain elevated in the short-term. As markets continue to process new data on inflation and economic growth, we see biotech likely fluctuating even more dramatically than the market as a whole. 

There are also risks related to the nature of drug development. Each clinical trial outcome is a binary event—either a drug candidate in development will work, or it won’t—and biotech stock prices often move sharply up or down as a result. But if a breakthrough emerges, we believe investors can realize outsized returns. 

SMID biotech investors should be comfortable maintaining a long-term perspective and time horizon. There will likely be disappointments and false starts, but over time, we have seen the biotech sector deliver strong results for investors, while making life-changing improvements for human health. 

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