What High-Risk Investors Can Learn From Keryx

Maxxwell A.R. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I had originally submitted this article over the weekend explaining why Keryx Biopharmaceuticals (NASDAQ: KERX) was a good sell hovering around $5 a share. Although the company had not released results from its Phase III perifosine trial the shares had returned a phenomenal 92.27% in the first quarter. There were many reasons to believe the trial would be unsuccessful, as I pointed out here in early January. 

I woke up on Monday to discover that Keryx’s X-PECT trial with perifosine for colorectal cancer had not reached its primary endpoint in patient survival. The molecule, licensed from AEterna Zentaris (NASDAQ: AEZS), is also in a Phase III trial for multiple myeloma. Management has stated that it will reevaluate the study to decide if it is worth continuing or if the company should focus solely on their ongoing Phase III trial for Zerenex.

Everyone has a different risk tolerance and being wrong is an unfortunate part of investing. So rather than bashing individuals for making one poor investment let us use this as a learning experience for high-risk, high-reward investors.

The problem with binary events

Like most risky stocks, many people were drawn to Keryx and AEterna by the possibility of gi-normous returns. It’s a sexy thing to think about making a few hundred percent on an investment. But when it comes to small, emerging pharmaceutical companies the risk often outweighs the reward. Few companies in this stage have enough revenue to withstand a failed drug trial. Therefore, an investment in a “Keryx” is usually tied to a binary event – success or failure.

My question is: why wait for a binary event to determine your investment outcome?

Five minutes could save your investment

If you are holding onto any risky assets then take a step back and consider the following scenario. Let’s say you were a huge believer in Keryx and bought shares at the beginning of 2012. You now think you have a good chance of hitting a home run. The shares hit $5, which represents an impressive 92.27% first-quarter return. Do you consider walking away with a near double in lieu of chasing a higher gain?

It’s never easy to walk away or know when to sell. Having the ability to evaluate any investment when the times are good could mean the difference between a near double and a substantial loss – as witnessed by Keryx on Monday. To help you visualize the “just walk away” option I have created a table of alternative investment returns and the associated periods it would take to equal Keryx’s first quarter:

<table> <tbody> <tr> <td colspan="2"> <p><strong>Alternative Investment Return Rate</strong></p> </td> <td> <p><strong>Alternative Investment Period</strong></p> </td> </tr> <tr> <td colspan="2"> <p>10%</p> </td> <td> <p>6.9 years</p> </td> </tr> <tr> <td colspan="2"> <p>15%</p> </td> <td> <p>4.7 years</p> </td> </tr> <tr> <td colspan="2"> <p>20%</p> </td> <td> <p>3.6 years</p> </td> </tr> <tr> <td colspan="2"> <p>25%</p> </td> <td> <p>3 years</p> </td> </tr> </tbody> </table>

 

It may seem a little easier to sell after doing a simple analysis such as the one presented above. I would consider all of these scenarios home run investments over a longer time horizon.

Foolish bottom-line

Do you like to invest in risky companies for a chance to hit the lottery? Try taking a step back and evaluating your riskiest assets. Write down the pros and cons of the investment, even if you have worked hard to convince yourself that your investment is worth it. Do you believe the risks still outweigh the rewards or should you consider leaving while you’re still on top?

Selling may not be the right choice. You may not even sell for a profit. I accepted a slight loss by selling Keryx at the beginning of the year. The decision wasn't easy, but it now looks like a much better option than waking up with a hole in my portfolio. Performing this simple check-up every so often will help you be less biased in your analysis of risky investments and could save you money down the road.

The bottom-line: don’t lose sleep over your investments.

Did you enjoy this article? Follow me on Twitter to keep up with my future posts on energy, sustainable chemicals, and biopharmaceuticals @BlacknGoldFool.


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