I found some very interesting information when conducting research on small-cap biotech stocks. Most disturbing: Well-respected analysts recommended an abundance of small-cap biotech stocks that have since been annihilated. My job is to give readers ideas where they can start research to not only potentially make money, but to stay away from dangerous names. It’s not going to do any good if I recommend looking into three stocks that appreciate 10% over a year if another one loses more than 50% of its value overnight. This is a very realistic possibility in the world of small cap biotech stocks and investors should be forewarned. (For more, see: Top 10 Biotech Stocks for 2015.)

The following stocks have been recently touted. Below you will see how these stocks performed over the past year as well as the past three months (all numbers are as of May 12, 2015).

Stock

3-Month Performance

1-Year Performance

Applied Genetic Technology Corp. (AGTC)

-22.84%

49.34%

Can-Fite BioPharma (CANF)

-30.36%

-43.05%

Lion Biotechnologies, Inc. (LBIO)

41.05%

27.32%

MEI Pharma, Inc. (MEIP)

-56.72%

-70.66%

Oncothyreon Inc. (ONTY)

-0.65%

-43.54%

OncoSec Medical Inc. (ONCS)

-22.50%

-60.20%

Peregrine Pharmaceuticals (PPHM)

4.80%

-24.28%

Sunesis Pharmaceuticals, Inc. (SNSS)

-5.83%

-58.08%

Synta Pharmaceuticals Corp. (SNTA)

2.64%

43.58%

TG Therapeutics, Inc. (TGTX)

14.57%

234.72%

Threshold Pharmaceuticals Inc. (THLD)

3.87%

0.27%

This chart is illustrates the risks one takes when “investing” in small-cap biotech stocks. It’s impossible to guarantee that you will be able to avoid misery. However, if you look at company fundamentals and what they've got in their pipelines, you will be able to at least increase your long-term odds of success. In order to succeed, you will have to avoid emotion and live with the idea that there’s potential for your invested capital to be completely wiped out. The upside is that it could, one day, turn into a multi-bagger. (For more, see: Biotechnology: Industry Handbook and Pharmaceuticals: Does the FDA Help or Harm?)

After digging into the list of stocks above, there wasn’t much of interest. However, Applied Genetic Technologies and Threshold Pharma at least looked as though they had some potential. AGTC develops gene therapy products for inherited orphan ophthalmology diseases in the U.S. The good news for AGTC is that it has a total cash position of $75.34 million vs. no long-term debt and negative operating cash flow of $14.61 million. This means it should have plenty of time to turn things back around. The problem is that insiders have been extremely accurate on when to buy and sell, and the most recent moves have been sales. That’s reason enough to use caution or avoid, but keep it on your watch list. (For more, see: When Insiders Buy, Should Investors Follow?)

THLD discovers and develops therapeutic agents that target tumor cells for the treatment of patients living with cancer. This story is intriguing for a few reasons. One, though small, there have been recent insider purchases. Two, revenue has increased annually, which also may make the firm appealing to larger companies. Three, the company has $58.60 million in cash and no long-term debt. Operational cash flow over the past 12 months is negative $27.74 million — that's a negative — but if revenue continues to increase and management proves to be efficient, then this shouldn’t be overly concerning. The most likely scenario here is that THLD will be around for a while, with many violent swings along the way. (For more, read: Biotech Firms vs. Pharmaceutical Companies.)

Others to Think About

Curis, Inc. (CRIS) is a speculative play on a company that manufactures drugs for cancer. These types of biotech firms are typically all over the place, but Curis does have one drug, Erivedge, that’s already been approved by the FDA. That led to a partnership with Genentech, which is now a subsidiary of Roche Holding (RHHBY). Interestingly, despite the consistent losses and low stock price, there is only a 4.20% short position on CRIS. Considering the circumstances, this is low, which is potentially bullish. The stock has also appreciated 38.81% over the past 12 months and 2.20% over the past three.

If you believe in following the money, then you might not want to consider ImmunoGen, Inc. (IMGN), given the whopping 18.78% short position. On the other hand, this company has delivered consistent revenue growth, a profit last quarter, and it has $106.60 million in total cash vs. no long-term debt. The problem is consistent annual losses and negative operating cash flow of $66.40 million. ImmunoGen develops targeted anticancer therapeutics and has a deep pipeline. The stock has depreciated 27.28% over the past 12 months but is up 22.34% over the past three. (For more, see: 3 Ways Arena Can Boost Shareholder Value.)

Ophthotech Corp. (OPHT) develops novel therapeutics to treat diseases of back of the eye. With the massive baby boomer generation aging, there could be potential here, especially since a relatively recent trial showed that its Fovista drug led to better vision improvement when used with Lucentis — drug that treats wet age-related macular degeneration — than when Lucentis was used alone. Novartis AG (NVS) owns Lucentis, and after seeing what Fovista could do, it scooped up the overseas marketing rights for $1 billion. Ophthotech still owns the domestic rights, so what's the story? Companies like Novartis will never go away because they will buy up winning drugs and treatments early by making incredibly tempting offers. This is an example of how the winners keep winning on Wall Street. A price tag of $1 billion isn’t much to Novartis, and investors receive peace of mind along with a relatively generous dividend yield. (For more, read: Novartis: A Primer.)

OPHT has appreciated 58.46% over the past year and depreciated 2.63% over the past three months. Novartis has appreciated 18.86% over the past 12 months and 2.74% over the past three. It currently yields 2.60%.

The Bottom Line

If you want to invest in small-cap biotech stocks, then don’t make any decisions until you dig deep yourself. The majority of these companies are likely to fail. The appeal is that the few that succeed will do so in a big way. The stocks listed above are ones to watch; they're not recommendations. If you prefer slow and steady returns over the long haul, have a look at Novartis. (For more, see: Top 4 Pharma ETFs.)

Dan Moskowitz doesn’t own shares in any of the companies mentioned above.

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