Allakos (NASDAQ:ALLK) is a clinical-stage biopharmaceutical company that recently saw a pretty dramatic price collapse at the end of December. I believe that ALLK stock, and its subsequent collapse, is a learning opportunity for the investing community.
In mid-December 2021, shares of Allakos were trading near $83 per share and they tanked to a stock price of $7.43 at close on Jan. 19, 2022. At some point last year, ALLK stock reached a 52-week high of $157.98. Now the 52-week low stands at $6.38 which is around where ALLK stock currently sits.
So is that a good reason to invest in Allakos now?
I argue that it is a naïve and very dangerous investment decision. Luckily for the investment community, Allakos has given us plenty of food for thought regarding the all too many common mistakes novice or uneducated investors make when they decide to invest in stocks.
There are at least five stock market investing lessons that Allakos has reminded me of. Here are my thoughts on all these.
1. Investment Markets Are Not Casinos
When you go to a casino the expectations to win playing various games are slim to none. People just want to have fun, enjoy, have a cosmopolitan lifestyle for a bit, and wish to get lucky and make a profit. They generally have no plan at all. Wishful thinking is the reason for gambling.
Stocks should not be anything like this. There is a business plan behind each company: good, bad; successful, or terrible. ALLK stock has been alluring investors to gamble on a business plan that is too risky and without delivering any results yet. It’s a clinical-stage biopharmaceutical company with no revenue yet.
Is it any wonder the stock crashed off its 52-week high?
2. Invest in What You Know
Biopharmaceutical companies are inherently very risky, and clinical-stage biopharmaceuticals are multiple times riskier as they do not generate revenue.
I argue that investors in these cases of biotech stocks do not dig deep enough into the pipeline products and ignore the underlying fundamentals. Investing in a stock without knowing inside out the real product or services of the company, the latest news and key catalysts is like going sailing without checking the weather or even knowing how to swim. The investment markets can be like a very stormy sea that, at times, will make you feel uncomfortable, scared, and anxious.
It is not wise to sail without checking the weather first, then why buy stock in a company you know nothing about?
3. Volatility Is Your Best Friend and Your Worst Nightmare
Highly volatile stocks can quickly stir emotions. Just remember the hot meme stocks back in 2021. Biotech stocks are in general very volatile and can either deliver stunning profits too quickly that tend to deflate also very fast or deliver massive losses over time.
The good news is that investors can educate themselves to recognize patterns of abnormal returns. It is like gambling again, investors bet on clinical trial news.
The problem is that these clinical trials have a very asymmetrical path of delivering stock price movements. It is a zero-sum game. Toss a coin and invest in the outcome. The chances seem to be 50/50 to win or lose. Not bad.
However, this is not a recommended investment strategy at all. The reason is that investors cannot apply stop-loss limits effectively when things go bad. A 10%-15% stop-limit when buying a stock seems reasonable. With ALLK stock, the stock tanked from a closing price of $84.39 on Dec. 21, 201 to an open price of $10.58 on Dec. 22, 2021.
Any reasonable stop-loss would not have been triggered and investors would be left wondering why they lost approximately 90% overnight.
4. Realistic Expectations Often Seem Boring
I also argue that in most cases investors supporting biotech stocks have unrealistic expectations.
We know that inflation is too high and that the Federal Reserve will increase interest rates in 2022. This is a big reason why why the stock market is having a rough first month in 2022 as expectations have changed.
Biotech stocks are not all the same. There are reputable companies with solid fundamentals. There are questionable firms. And then there are companies like Allakos, with dreadful fundamentals.
Why would a company with zero revenue be expected to perform well?
What drives value for the investors?
The answer is the fifth reason below: strong fundamentals and attractive valuation.
5. Ignoring the Fundamentals Can Be Disastrous
At first glance, investors can discover two red flags for Allakos.
The company is unprofitable, has zero revenue and shareholders have been diluted in the past year, with total shares outstanding growing by 3.4%.
Analyzing the fundamentals of each public traded company puts the odds in your favor to make wise investment decisions. Not all your investment decisions will be a success, this is impossible, and there are no guarantees of outperforming the broader stock market. There is however a method, called due diligence that allows sorting great stocks from junk stocks. Finding a stock with great fundamentals is a start. Valuation is another story.
Allakos has a cash burn problem but has no debt yet on its balance sheet. Does this make it a company to invest in because it has a strong balance sheet? How does the company pay its operating and research and development expenses when it generates zero revenue?
Fundamental analysis may seem a tedious task at first to novice investors. The truth is that it is far easier than most think. The key concepts of analyzing financial ratios to evaluate stocks can be learned easily without any excuses. Valuation, however, is another story, but at least relative valuation can also be taught easily.
Bottom Line on ALLK Stock
Biotech stocks are a special category of investments that can easily turn from hot to cold in the blink of an eye.
If you study more of the fundamentals of stocks and stock trading then you can be more aware of the warning signs. And Allakos stock had severe warning signs foretelling of its collapse.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.