8 Stock Picks to Bet on Beating Cancer

A cancer diagnosis was once a death sentence -- particularly if you were diagnosed when the disease was at a late stage. But experts say that recent clinical trials and treatment breakthroughs show real promise. That's given patients new hope -- and caused investors to bid up the prices of biotechnology companies that specialize in cancer cures.

Although only a handful of these biotech companies are currently profitable, investor optimism is warranted, says analyst Geoffrey Porges, of Bernstein Research. Both government and industry have poured enormous sums over the past decade into researching how cancers develop and spread, vastly improving the development of effective treatments.

The new protocols are hitting on several fronts. One approach finds ways to boost the ability of the body's own immune system to recognize and kill malignant cells. Another identifies unique chemical characteristics of cancer cells and magnetically sends therapies to destroy just those cells – as opposed to traditional chemotherapy, which kills healthy cells, too. A third approach attempts to block the pathways by which cancer cells spread throughout the body. If doctors can block some or all of those passages, they can retard the spread of disease and vastly improve the chance of killing the trapped cells before they escape and multiply.

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But cancers come in a wide variety and, thankfully, the chance of a person getting an individual strain is relatively slight in any given year. So, unlike high blood pressure, which affects so many individuals that big drug makers can afford to fill labs the size of football fields with scientists working on remedies, cancer cures are often addressed by small companies with a modest team of specialists.

For investors, that presents both challenge and opportunity. Small companies with just a few drugs in development can be decimated by the failure of a single clinical trial, sending both the company and its investors into an economic tailspin. Consider, for example, Geron (symbol GERN), a Menlo Park, Cal., company that had been in the middle of Phase II clinical trials for a breast cancer treatment (see below for an explanation of the different phases of the drug-testing process). When the company announced in early September that the trial was going badly and would be discontinued, the stock lost more than half its value in one afternoon, going from its close of $2.90 a share on September 7 to $1.28 on September 10.

Clinical trials are everything, adds Karen Andersen, an analyst at Morningstar. When a biotech outfit has a drug in early Phase 1 clinical trials, analysts figure the company has a 10% to 20% chance of coming out with a marketable drug. But as it successfully completes each trial, the chances rise -- and analysts start to boost their estimations of value -- often by exponential amounts. Still, almost anything can happen before a drug gets final regulatory approval. "These are inherently risky assets," says Porges.

On the other hand, if a drug proves effective, the small company you invested in could suddenly have the potential to rake in billions in sales, and its stock could make you rich overnight. That's essentially what happened with Medivation (symbol MDVN), a San Francisco company that's working on prostate cancer cures. Less than a year ago, the stock was trading at $17. But with a newly approved prostate cancer drug, the biotech company, which is still unprofitable, now trades for $53.38 (all share prices are as of October 11). Medivation remains one of Porges's top picks. He believes it will hit $65 within a year.

Here are seven companies working on cancer cures – in addition to Medivation -- that experts believe are worth the gamble.

RBC Capital Markets biotechnology analyst Adnan Butt has four cancer stocks on his buy list: Spectrum Pharmaceuticals (SPPI) has the most advanced product chain of the stocks he's recommending, given that it already has three drugs on the market and 11 in the pipeline, including drugs to treat lung and bladder cancers. Unlike many of the other hot biotech prospects on the list, Spectrum, based in Henderson, Nev., is profitable. During the first six months of 2012, its earnings tripled to $64.6 million, or $1.10 per share, from $19.9 million, or 39 cents per share, during the same period a year ago. Revenues were up 48%. That kind of growth normally begets a sky-high price-earnings ratio, but Spectrum, at a price of $11.94, sells at less than 8 times estimated 2012 earnings of $1.53 per share.

What's holding Spectrum back is that its key drug, Fusilev, which treats advanced colorectal cancer, now has a generic competitor and investors are concerned that its customers will abandon the drug for a less-expensive alternative. Indeed, analysts on average are projecting that earnings will decline in 2013, to $1.20 per share.

But these concerns are overblown, says Butt, who has a one-year price target for the stock of $17. "In my opinion, investors are not paying any attention to the pipeline. I think they'll become less cautious as they see sales hold up and we get more data on their new drugs this fall and next year."

Butt likes two other companies – Seattle Genetics (SGEN) and Endocyte Inc. (ECYT) for exactly the same reasons. They both have late-stage cancer treatments that rely on small-cell technology that home in on cancer cells much like smart bombs track a terrorist. By targeting the diseased cells without harming the healthy cells, Butt says, they can deliver a much more potent drug cocktail than they could with traditional treatments.

Seattle Genetics' treatment for Hodgkin's lymphoma, Adcetris, has received a conditional approval and is now available for some uses. Endocyte is in Phase III trials with a drug that treats ovarian cancer. But the specific cancer that's being treated isn't what makes these companies worth buying, says Butt. It's the technology that delivers the drugs to individual infected cells. The technology is tough for competitors to replicate, yet it appears to have applications for many types of cancer. That gives these companies potential that far exceeds the drugs that are in the final trials.

Unfortunately, both Seattle Genetics and Endocyte are losing money and are expected to continue to spill red ink for at least the next few years. The stocks trade at $24.71 and $10.38, respectively.

Butt also likes ImmunoGen (IMGN), a Waltham, Mass., company that attempts to cure cancer by boosting the body's own immune response to malicious cells. It's in Phase III trials for treating metastatic breast cancer; it has another drug that's in Phase II trials to treat lung cancer; and it is in earlier stages of developing drugs that would treat lymphoma, leukemia and multiple myelomas.

ImmunoGen is also unprofitable and likely to remain in the red for some time, as it pours cash into drug research and development. That makes it hard to place a value on the companies -- particularly over the short term. Still, Butt thinks they're worth buying. "Investors should buy these stocks and forget about them for a while because, over time, they will be worth a lot more than they are now."

UBS analyst Matthew Roden recommends Incyte (INCY), which also treats cancer through small-cell technology. The Wilmington, Del., biotech company has a host of drugs in Phase II and Phase III trials that would treat several rare types of blood cancer, and it's in earlier-stage trials with drugs to treat more-common ailments, such as rheumatoid arthritis and psoriasis. The company is on the cusp of releasing trial results that could convince the market that the drugs are viable and cause the stock to soar. He thinks the company's shares will sell for $26 within a year -- a 52% premium over the current price of $17.13.

Morningstar analyst Andersen considers Exelixis (EXEL) an even better bet. The company is in Phase III clinical trials with a drug, called cabozantinib, for the treatment of thyroid cancer. But the same drug appears capable of attacking several types of cancer, including lung and prostate cancer. Exelixis has numerous other drugs in late-stage trials, too, making it a "multiple-shots-on-goal story," says Andersen. The stock is still plenty risky, she adds. But if the company's drugs prove to be as effective and versatile as she thinks they'll be, Exelixis could double in price. Andersen thinks Exelixis is worth $11 a share, more than twice the current price of $4.81.

Onyx Pharmaceuticals (ONXX) has been one of the year's hottest stocks, more than doubling in price over the past year. Yet Deutsche Bank analyst Navdeep Singh thinks the stock has plenty of room to run, given the prospects for the company's recently approved drug for multiple myeloma, which could ring up $3 billion in annual sales as soon as next year. Onyx is already involved in a partnership with Bayer HealthCare Pharmaceuticals with drug that treats kidney and liver cancers and generates $1 billion a year in sales. And Onyx's drug formula, which uses "inhibitors" to block the spread of disease, is also being tested for treatment of many other serious auto-immune disorders, including rheumatoid arthritis and lupus. Although Onyx hasn't yet become consistently profitable, Singh believes Onyx, which now sells for $88.77, will reach $105 within a year – if a big drug maker doesn't buy Onyx before that for an even more generous price.

The 3 Phases of Drug Testing

The value of a company that's working on cancer cures often hinges on how far its drugs have progressed through clinical trials. The U.S. Food and Drug Administration requires drug makers to navigate a three-stage testing process aimed at proving a drug's safety and effectiveness.

A new drug is first tested on humans in Phase One trials. The main goal of this stage of testing is to determine whether a drug is effective and whether it has serious side effects. These trials also attempt to determine the right dose of medicine, and which types of illness a drug may effectively treat.

If the side effects are limited and the drug appears effective, Phase Two trials can commence. Now the drug is used only to treat a specific type of illness in a larger group of patients. The aim is to see how well the drug treats the disease at a predetermined dosing level and whether patients can tolerate it well.

In Phase Three trials, the benefits of the drug are compared with those of existing treatments. Patients getting the new treatment are chosen randomly and generally not told which treatment they've received. The aim is to determine whether the new treatment is better than the old. Because differences may be subtle, this stage of trials often takes longer and involves hundreds, or even thousands, of patients. If the drug is ultimately proved both effective and safe, the results are provided to the FDA for evaluation and approval.

Kathy Kristof is a contributing editor to Kiplinger's Personal Finance and author of the book Investing 101. Follow her on Twitter. Or email her at practicalinvesting@kiplinger.com.

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