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Ignore the hype -- research health, biotech stocks carefully

Tuesday, September 22nd, 2015

This company just lost 78 percent in one day. Could this happen to you?

There has been a lot of stock market buzz and excitement surrounding the health care and biotech companies.

Many of these companies do not trade on the underlying values of the company's fundamentals, but instead the hype and prospects for what the company can do.

Investors get very excited over the company's potential to come up with the next big drug that could cure cancer, AIDS or other serious diseases.

While this is all very promising, many of these health care and biotech companies are not making any money, and are producing negative earnings. The hopes of what these companies could become have inflated their stock prices far beyond where they should be.

Tetraphase Pharmaceuticals Inc. (Nasdaq: TTPH) is an example of a biotech company that traded on the excitement of the potential future the company could have.

The company's stock price quickly inflated from $14.95 on Sept. 8, 2014 to $44.78 on Sept. 8, 2015. That's a return of 199.53 percent. The stock price was elevated by the potential of the drug Eravacycline.

This product candidate is an oral antibiotic for the treatment of multidrug-resistant (MDR) infections. The drug was in a phase 3 program called Ignite.

Ignite 1 investigated the safety and efficacy for the treatment of complicated intra-abdominal infections, while Ignite 2 looked at the drug's safety and efficacy for complicated urinary tract infections.

After the market closed on Sept. 8, 2015, Tetraphase Pharmaceuticals reported that Ignite 2 missed in its Phase 3 study and the drug met neither the U.S. nor European Union standards. This led to a plummet in the stock price as it opened at $9.64 on Sept. 9, 2015. That's a one-day loss of 78.47 percent.

If investors would have relied on the company's fundamentals, rather than the hype surrounding the stock, this loss of 78 percent would have been avoided.

Price-to-earnings for this company cannot be evaluated. The company currently does not have a P/E or a forward P/E.

This is because the company produced earnings of negative $2.49 per share for the year ended 2014, has an expected loss of $2.62 per share for 2015, and has an expected loss of $2.21 per share for 2016.

Price-to-sales for the company is 134.35, which is much more expensive than the industry at 10.55.

Looking at the return on capital (ROC) and return on equity (ROE) over the last 12 months, it is apparent that management has improperly allocated investments.

ROE takes a look at how much profit a company generates with the money shareholders have invested. ROC takes a look at how much profit a company generates with the money invested from long-term debt and shareholders.

Tetraphase has an ROE of negative 55.96 percent; we like to see this number above 15 percent. Its ROC is negative 55.33 percent; we like to see this number above 10 percent.

Taking a look at the financial results from the most recent quarter, the story only gets worse for Tetraphase Pharmaceuticals. Their income after tax margin was a negative 697.54 percent.

To put this in perspective, on sales of $3.34 million the company had a net loss of $26.04 million.

Based on the fundamentals of the company, Tetraphase Pharmaceuticals should have never been a buy. Investors allowed their emotions and the excitement about the company's future to influence them into thinking it was a good buy.

Tetraphase Pharmaceuticals is not alone in the biotech industry, there are many companies that have had their stock prices inflated by future prospects. These companies are very risky, because we do not know if those drugs will be approved.

As we have seen with Tetraphase Pharmaceuticals, if the company's drugs do not live up to expectations their stock price could plummet.

At the end of the day, investing in these risky biotech companies is no better than going to Las Vegas for a weekend of gambling.

To avoid risking your money it is important to do the research and find those high quality companies to invest in.

Do you have a question or a company you would like us to take a look at?
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