Moonshot shares

The existence of this phenomenon shouldn’t be a surprise. Research into investor behaviour has found strong evidence to suggest that many market participants – and retail investors in particular – are attracted to assets with positively skewed returns. In the hunt for these returns, past market outperformance or the promise of all-or-nothing future corporate events are reliable ways to steal that attention.

On balance, this frequently leads to asset overpricing, confirmation bias and lower subsequent returns. Troughs often follow peaks, as this feature will show. But it’s unlikely that this feature of market and investor behaviour will ever disappear. Millions of people continue to play the lottery, after all.

But what is it that draws investors to lottery stocks? According to one recent study, several factors induce the mad dash for the multibagger: high retail investor ownership, extreme recent positive returns and high earnings surprises. To this, we can add two modern drivers: stocks headquartered with high Facebook social connectivity and Google searches in response to sharp share price movements. The internet has added a viral quality to price movements.

This piece looks at two sectors whose promises, hype and business structures have a habit of magnifying this viral quality: pharmaceuticals and resources. Quantifying which is the more fertile ground for the multibagger stock, and which is more deserving of the hype, isn't an easy task – when you’re shooting for the moon it’s easy to miss, after all. But understanding the drivers that propel investors’ enduring fantasies of multibagger returns, and the areas of both sectors that help to offset the high risks, is always an important lesson. AN

Bagging a medical marvel

Investing in a company that has set out to cure disease has a lot of attractions. There’s the sense of altruism, the intrigue and the ultimate goal for anyone who puts their money in the stock market – to make that money go further. Drug companies are enormously profitable, so it isn’t unrealistic to assume that a business that can successfully launch a new medicine will make an awful lot of money for its backers.

The reality is not quite so simple. Major medical breakthroughs might originate from a small team of scientists in a university or research and development centre, but most are ultimately commercialised by a big pharmaceutical company, which profits from the success. Small-cap companies have a notoriously poor record of profiting from major medical breakthroughs, especially in the UK. We might be good at science, but we’re not always very good at making money from it.

A market in waiting

Still, every year hordes of investors flock to the UK’s small drug development sector in the belief that it might land them with a multibagger reward. They’re not totally naive in their collective quest. The market has key qualities that make it a good environment for multibagger hunting; crucially an abundance of smaller stocks.

The predictability of the market’s reaction to do-or-die events is part of the appeal of a drug development investment. It may be impossible to foresee the outcome of a clinical trial, but once announced, investors can be sure which way the share price will move. In June 2017, Oxford BioMedica’s (OXB) share price nearly doubled in one day after the gene therapy that uses its technology successfully completed a phase two clinical trial. From the start of 2016 to its multi-year peak, Oxford BioMedica’s share price rose 400 per cent. By contrast, Circassia (CIR) shares collapsed in 2016 after the final-stage failure of a cat allergy treatment, and its share price remains less than 10 per cent of its value on the day prior to the trial announcement. Both responses are typical of drug development companies of any size.

But unlike the outcome of clinical trials, stock markets are not black and white. Investors gossip, company management creates hype and analysts attempt to predict the future, which all leads to major share price movements before a company has even completed a clinical trial. Faron Pharmaceuticals (FARN), Summit Therapeutics (SUMM) and Allergy Therapeutics (AGY) are excellent examples of that market quirk. As the charts below indicate, their share prices more than doubled between 2016 and their respective peaks, thanks largely to the anticipation of clinical trial results. With enigmatic founders at the helm, all three welcomed some big institutions on board thus encouraging many private investors to take a slice of the company. All three have since failed a clinical trial which wiped out all the share price gains and more, as the disappointment of the failure was amplified by the preceding hype.

Faron, Summit and Allergy ticked many of the boxes we highlighted in last year’s feature ‘Seven Steps to Healthy Profits’: they were all focused on a hot scientific field, had identified a niche product, were led by experienced management and had clear commercial strategies. But they all stumbled at a crucial hurdle that no amount of business excellence can avoid – they failed a clinical trial.

These three companies are therefore prime examples of the problems with hunting for a multibagger in the drug development arena. In the early years, their value is based on the very binary outcome of a clinical trial. Until that trial has succeeded or failed, the value of the company is entirely dependent on investors’ perception of the chance of success. Once the trial has succeeded the value is based on the company’s ability to make money from that drug in the ultra-competitive pharma market. If it fails, there is very little left on which to base a valuation argument. If Circassia’s experiences are anything to go by, investors don’t tend to forget a failed clinical trial easily.

In most sectors, missing multibaggers is assigned to a lack of patience – failing to hold on to the company long enough to benefit from the growth. In the UK’s small drug development space, the opposite is often true: investors miss out on big, if not multibagger gains because they have failed to cash in their winnings, as the table below shows.

Several of the UK’s smaller drug developers have seen their share prices accelerate in the run-up to a drugs trial and then retreat

Slim-pickin’ the winners

In recent years, only one British pure-play drug developer has truly conquered the industry. GW Pharmaceuticals (US:GWPH) – now, ironically, US-listed – spent 10 years researching and developing a novel cannabis-based medicine for the treatment of the symptoms of extreme forms of epilepsy. GW joined Aim in 2001 with a share price of 182p. Several positive clinical trial results and 15 years later, the shares had multiplied by 4.5 times (although the company was still not making any money) and management left Aim in favour of Nasdaq.

The stars have aligned for GW Pharma – the timing of its drug launch has come alongside a greater acceptance (both socially and legally) of the use of cannabis to treat illness. GW has managed to successfully launch its medicines in this completely novel area of the market before the big pharma competitors begin to crowd its space. Its US share price is now three times higher than when it left Aim in 2016.

But even among its US peers, GW is a rare gem. Many companies that manage to launch new medicines struggle to drive profitable growth. For example, in 2018 Spark Therapeutics (US:ONCE) became the first company to launch a gene therapy that cures an inherited form of blindness. But it remains lossmaking and hasn’t managed to book particularly impressive revenues from its medicine, while its share price has lagged the wider market. In most cases, the best a drug developer and its shareholders can hope for is a value-enhancing takeover. This year, Amgen (US:AMGN) paid $13.4bn for a medicine that is still in the early stages of clinical trials.  

Thinking outside the box

But drug development is not alone in the UK’s healthcare market. In fact there are just as many life science services and tools companies traded on Aim as there are pure-play drug developers. Antibody catalogue business Abcam (ABC) is one of Aim’s most successful companies. It arrived on the stock market in 1998, not long after the company’s founder, Jonathan Milner, had progressed from selling antibodies out of an ice bucket at Cambridge University. A profitable business model in a specialist niche market, led by a heavily-invested founder was a perfect recipe for multibagger success. The company’s share price peaked in August 2018 at 1,516p, more than 15 times its IPO price. A new boss and a shift in strategy has left the outlook a little murkier, but the model is one that many of Aim’s small pharma investors would like to see replicated.

Enter Bioventix (BVXP) – its share price rose 253 per cent between the start of 2016 and its peak, and it is one of the few Aim healthcare companies still trading near its all-time high. Like Abcam, Bioventix sells antibodies, but its superior quality products are aimed at a different market to its larger cousin. Bioventix antibodies are licensed out to large diagnostic companies to detect evidence of disease in the blood. Its share price has ticked upwards in the past five years as it develops new antibodies and secures long-term licensing agreements with some of the largest companies in the blood testing industry. As with most licence businesses, it has extraordinary operating margins, throws off cash in buckets and enjoys a secure stream of royalty payments. The company listed in 2014 at 595p a share and at the time of writing its share price is 3,552p. With demand for its antibodies still rising strongly and generating huge volumes of cash, many investors expect Bioventix to reach that elusive 10-bagger status before long.

Aside from Horizon Discovery, the healthcare tools, services and equipment companies have been some of Aim’s best performers in recent years:

Hunting for treasure

Sticking with the tools and services division is probably the best strategy for those seeking a multibagger healthcare stock in the coming years – seven of the 13 Aim-traded companies in the industry that have seen their share prices at least double in the past three years operate in the tools or services space. These companies are less prone to sudden shocks and can be valued on more traditional metrics than the blind hope of a successful clinical trial. Their long-term success also aligns better with Warren Buffett’s widely held view that the best way to make money from the stock market is to find shares that you can buy and hold forever.

That’s not to say drug development doesn’t have the capacity to throw out some major winners over the long and short term. But picking them and knowing when to pocket the winnings is a far harder game to play. Like an investment in small-cap commodities, it pays to cash out before sentiment swings. MB

Digging for winners 

Mining, and oil and gas get messy when you actually have to get the stuff out of the ground. This means – barring years or decades of patient shareholding as a well-run company expands – a multibagger is much more likely to be found quickly in the exploration sector. It’s also easier to get from 1p to 10p than from 100p to 1,000p, which explains why retail investors often conclude that the juniors are the ones to look at. 

Like any cyclical industry, finding success in resources is a question of picking a mining company about to find a lot of a hot commodity or an oil and gas driller about to make a big discovery. This is less value investing, more speculative punting. Risks include big drill hits not being converted into mineable deposits, host governments changing the rules and chief executives setting themselves up for a fall with outlandish development forecasts. 

For oil and gas companies the great rerate happens when a discovery is declared, while miners’ shares can benefit from the incremental approach towards a strong resource base. Or a gimmick, as Canadian-listed Novo Resources showed; the gold explorer beamed video of a metal detector-wielding geologist in a trench into a gold conference and the same thing happened. Novo had already had its Eureka moment, climbing 563 per cent to C$5.44 (£3.31) between 30 June 2017, and mid-August of that year, but the conference stream kicked it up into three-month tenbagger territory.  

Companies with a less hyped resource can also do well – they just need a lot of it. Bluejay Mining (JAY) made it from under 1p at the end of 2015 to 26p in early 2018 because it showed it was sitting on a gigantic titanium resource in Greenland. The wait for permitting and missed deadlines have since seen it return to under 10p, but it was a big winner for some. 

Just as with drug discovery, that lesson is a key part of the multibagger mystery – when to get out. There are better examples than Bluejay, which still has a project rumbling along, but anyone out for a multibagger return will probably be waiting some time before the company returns to its highs. An industry veteran told us he was sitting on an investment that had grown by a multiple of 43 since he bought in, but had not yet sold. 

So if we take that as a broad framework for picking multibaggers – an oil or gas discovery or the revelation of a promising deposit for mining – let’s see if there is a way to identify them before they go haywire. 

The good stuff 

The real excitement in resources for investors is when a tiny company gets a bonanza drill hit or gusher. Eco Atlantic Gas & Oil (ECO) is a dual-listed explorer that has managed so far to hold its value through a run of positive results since joining Aim at 16p in February 2017. The biggest kick so far was the discovery confirmation at the Jethro-1 well in Guyana in August, bringing it to over 100p. Momentum and good news on the Joe well caused Eco Atlantic to briefly pass 200p in September. Much of the groundwork had been done at the Guyana offshore project, where Tullow Oil (TLW) is a partner, and it was a prospective area where ExxonMobil (US:XOM) was also getting good results. 

UK Oil & Gas (UKOG) shareholders have had a different experience. The company made a wildcat onshore discovery in England’s south-east in 2015, and promptly began talking about the billions of barrels it said could come from the ‘Gatwick Gusher’. The share price more than doubled on that news, but it was the 2017 well tests that really got UKOG going: there was a 700-plus per cent return on holdings bought around 1p in early June that year, and the share price passed 800p by September. An amazing run for any company. But, as usual, the tricky part is realising those gains. Anyone who had bought before the rise and sold at the end of 2017, when the share price was back down to around 300p was still in the money. Waiting another six months would have cost another 100p a share, and the company is now trading at 120p.

Recent successes in the oil and gas space have been two-baggers maximum. Energean Oil & Gas (ENOG) is trading around double its opening share price in London of 437p off the back of progress at its Israel gas project, and Diversified Gas & Oil (DGOC) has grown the same, reaching 113p in September after listing at 56p. These aren’t the single-well-driven growth stories further down the Aim lists, but they’ve kept on growing even as oil and gas prices have been relatively weak.

Mining options 

A reliable area of research for resource multibaggers in recent years has been the energy mineral juniors. In 2016-17, companies previously looking at base or precious metals suddenly remembered they had some cobalt behind the couch, or got their hands on a lithium project. Those have largely petered out, and even companies that already had projects on the go (Bacanora Lithium, for example) have found the going tough as excitement and prices have waned. But lithium companies do show a repeatable path to multibagger success: buy a cheap project and announce drill results.

Kodal Minerals (KOD), named for the location of its phosphorus and iron project in Norway, was trading at 0.05p in the middle of 2016. In August 2016, Kodal announced it had spent an initial $25,000 on a lithium licence area in Mali. Chief executive Bernard Aylward was open about the intent behind the purchase: “The market dynamics surrounding lithium are highly compelling,” he said. Aim investors agreed, and Kodal’s share price climbed from 0.05p to 0.16p. But it was rock chip sample results in December 2016 that really turned Kodal into a star, with lithium-bearing pegmatite confirmed at the site. This saw the share price go from 0.08p to 0.51p, a change of over 500 per cent. These were rock chips, which give little information beyond the mineral being present. Kodal is still developing the project, but since the lithium price has dropped its share price is back to 0.07p. 

Picking winners from a greenfield or wildcat explorer can be lucrative, but there’s also a good chance of a rerating if a miner buys an old project on the cheap and can keep afloat long enough to get it into production. SP Angel analyst John Meyer likes the brownfield approach. “Investing in the discovery, definition, evaluation and development of any old mine is probably a multibagger idea,” he says. “It doesn’t always work, but sometimes it works really well and that more than pays for any failures in my experience.” 

Current examples of this are: Phoenix Copper (PXC), which is reopening the Empire mine in Idaho; Bluebird Merchant Ventures (BMV), developer of the Gubong gold mine in Korea; and ASX-listed Apollo Minerals, which has a tungsten mine on the French-Spanish border. Copper miner Atalaya Mining (ATYM) is a good example of how this can be done successfully, although it took far longer than expected, and anyone who bought before 2015 is still likely to be sitting on a loss. 

Asking a pro

Orion Mine Finance is a major private equity player, buying into juniors around the world. Portfolio manager Philip Clegg was on the Investors Chronicle Extraction podcast this month and explained how he picked juniors. He has technical advisers and will spend months on due diligence before taking the leap, but his pre-deal work holds some tips for retail investors. Mr Clegg said the cost structure of an asset was the key point. Low-cost producers will withstand weak price environments. If the junior in question is not yet able to quantify costs, then the quality of the team is very important. He recommends looking for an executive group able to raise cash and build a mine. That means a proven record of getting projects up and running.  While this is broad advice, it’s easily translated to an early-stage company. Has the management built a mine before? How much do they think it will cost to extract each ounce or barrel? What are their price assumptions? Shades of grey will come up in these answers, but they provide a framework that encourages a sceptical starting position. 

Applying those to Aim explorer Cora Gold (CORA), as an example, we get a tick for chief executive Jon Forster’s experience (he has found deposits before) and there is a non-executive director who sold the promising Yaoure project on to ASX-listed Perseus Gold, so there is good M&A experience. The assumptions going into the Sanankoro project can’t be tested pre-scoping study, but the company is heavily linked to Hummingbird Resources (HUM), which got the Yanfolila mine up and running, so there is practical experience there too. Cora’s share price is half of its listing price of 15.75p despite the strong gold price. Edison analyst Charles Gibson has identified the time before the scoping study as when many gold companies reach their highest valuation in the exploration and development phase, so Cora is either going against the trend identified by Mr Gibson, or is just about to skyrocket. Who could know? 

Within the resources sector, it’s clear that what goes up does not have to come down. But it’s easy to look back at companies that have shot up and come down again due to commodity movements or shareholders losing interest over development delays. Picking the next one is difficult, and made more difficult by the noise generated by microcaps across forums and social media. If you do land on major returns, remember the cash is not yours until you sell out. AH