If you can do the mental work to separate your sentiment about a stock from its recent price action, buying the dip in a recently dented winner can be a profitable investing strategy. Of course, it's key that you determine whether a business is experiencing a temporary setback or a more durable downturn before making the decision to buy. That can make the difference between buying the dip and making more money later, and buying the dip only to see your investment's value decline further.
On that note, Compass Pathways (CMPS 0.83%) stock fell by 9% on June 4, and the stock is down 20% this year so far. It didn't report any bad news on that day, nor has it done so this year. So is this a great opportunity to buy the dip, or is the recent decline a symptom of a more serious issue?
What's causing the dip
Compass is developing interventions for mental health issues. Its interventions are, at their core, molecules that are known to the public as psychedelic drugs, like psilocybin (the active ingredient of "magic mushrooms").
The biotech's lead program, COMP360, is in phase 3 clinical trials right now, and it's being developed to treat treatment-resistant depression (TRD). Unlike most medicines intended for psychiatry, COMP360 has two components: psilocybin, and psychological support provided by a trained clinician. In theory, by helping patients to prepare for a psychedelic experience, guiding them through it, and then helping them to integrate it into their psyche in a healthy way, Compass hopes that its protocol for psychological support can squeeze the most efficacy out of the psychoactive component of the therapy while minimizing safety concerns.
But Compass isn't the only company testing the pairing of a psychedelic molecule and skilled support staff. Lykos Therapeutics, a public benefit corporation (PBC), recently concluded its own phase 3 clinical trials investigating whether its combination of MDMA ("ecstasy") and psychological support might be helpful for severe cases of post-traumatic stress disorder (PTSD). The results of the trial were promising and offered few red flags as far as side effects are concerned. So, Lykos filed a petition to commercialize its candidate with the Food and Drug Administration (FDA).
On June 4, a non-binding advisory committee at the FDA voted overwhelmingly to reject Lykos' application. On Aug. 11, a binding committee will deliver the final verdict about approval, but the odds are now grim, as the committee with the ultimate power of granting approval usually does not vote differently than the advisory committee. As a longtime observer of the psychedelics industry, the FDA's vote shocked me, as the prevailing sentiment among investors in the space was that a positive vote was the more probable outcome.
This is the reason why Compass' stock, as well as other psychedelics stocks, took a serious hit. Look at this chart:
SPY Total Return Level data by YCharts.
Psilocybin, much like MDMA, is currently an illegal drug in the eyes of the law. Laws and regulations can change. But a significant part of the theory of how prohibition laws might change in favor of psychedelics companies is that regulators at the FDA would put in a good word with the Drug Enforcement Agency (DEA) and legislators as a result of seeing a corpus of scientific and medical evidence supporting the use of such psychedelic molecules as genuine medicines. And those regulators essentially just said the body of evidence isn't up to snuff yet in terms of its quality or its bulk.
There is no guarantee that COMP360 will meet the same (potentially temporary) fate as Lykos' program did. It still needs to conclude its phase 3 trials, so there is plenty of time to run additional studies or extend existing ones to account for whatever it is that regulators seem to want more emphasis on in the packet of approval materials.
The right move won't be the same for everyone
All said, should you buy the dip on Compass stock?
If you're still seriously asking that question, chances are you have a high enough risk tolerance. With such a frame of reference, I'd argue that it should be okay to invest in the stock -- knowing that the products Compass intends to sell are still illegal, along with the latest setback for MDMA. Here's why.
Fundamentally, Compass Pathways stock is being buffeted by problems that are beyond its control. While it had an interest in seeing Lykos successfully navigate the regulatory process, thereby providing an official stamp of much-needed credibility to all of the other efforts to develop psychedelic medicines, its interest was not a financial one. It will not need to pay to remedy Lykos' troubles, but it will still capture the benefits of not being the first company to take a shot at approval, which could be decisive.
The biotech also has enough money on its balance sheet to adjust its course to avoid the same problems. Its cash, equivalents, and short-term investments of $263 million are sufficient to cover its trailing-12-month (TTM) operating expenses of $132 million for nearly two more years. At the same time, the company only has $29 million in long-term debt. Therefore, if COMP360's phase 3 trial yields favorable results, which would be in keeping with the previous data, it will probably not struggle to borrow more cash if it is necessary.
Thus the investment thesis in favor of buying Compass shares before this latest incident -- which held that it would be the first publicly listed biotech to commercialize a psychedelic medicine, thereby enabling it to access difficult and underserved segments of the market for psychiatry drugs -- is still as valid as ever. Holding its shares for at least a few years will be necessary for any dip-buyers to get a decent return.
It's true that the regulatory picture is now riskier. But, in a different sense, Lykos' poor fortune could actually de-risk Compass' attempt at commercialization down the line, so it isn't a dealbreaker.
