Is Compass Pathways a Buy?

Pharmaceutical company Compass Pathways (NASDAQ:CMPS) is a stock that most investors have likely never heard of but which could produce large returns over the coming year.

 

The company is in the process of obtaining approval for a new class of anti-depression treatment, potentially allowing it to serve a large group of patients who don’t respond to currently available therapies. Here’s the skinny on this potentially hot stock.

 

Compass Pathways is a mental-health-focused pharmaceutical company that is developing psilocybin-based treatments for patients suffering from depression. Founded in 2016, the company has developed a proprietary form of psilocybin called COMP360 for cases of major depressive disorder that resist more traditional treatment options.

 

One of the most compelling arguments in favor of Compass Pathways is the fact that COMP360 has been designated as a breakthrough therapy by the FDA following a Phase B clinical trial.

 

Treatments that gain this designation are eligible for a faster approval track, potentially reducing the time and expense associated with gaining FDA approval.

As an experimental pharmaceutical company that was only founded in 2016, Compass Pathways is still in the phase of its business marked by losses and large R&D expenses. In Q2, the company reported a net loss of $21 million. This marked an increase in losses from $17.5 million in Q2 2021. These most recent quarter’s losses resulted in EPS of -$0.50.

 

Management currently expects to be able to fund its research using present cash reserves until 2024. Compass Pathways holds $205.7 million in cash and equivalents.

 

It should be noted, however, that accelerated spending on research and development will likely begin eating into this reserve at a fairly rapid rate. Since the end of 2021, the company has already spent over $65 million of its cash position.

To say that analysts are bullish on Compass Pathways would be an understatement. All 10 analysts offering ratings on the stock have rated it as a buy.

 

The median target price for Compass Pathways is $63. Given the stock’s most recent price of $16.79, this would give Compass Pathways a one-year upside of over 275 percent. Even the lowest analyst price target of $30 would result in a return of 78.7 percent.

 

Despite these extremely optimistic projections, though, investors should still approach Compass Pathways with a degree of caution.

 

While it’s possible that Compass Pathways could produce such large returns, a more conservative set of assumptions is likely warranted.

 

In the past 52 weeks, the stock has traded in a large range of $6.54-49.51. This level of volatility makes it unwise to assume that the stock will nearly triple in the coming 12 months.

 

Because it has not yet achieved profitability or brought in any significant revenue, Compass Pathways is more difficult for investors to assess from a value perspective than most companies.

 

One useful metric is its price-to-book ratio, which stands at a somewhat high 3.18. The prevailing industry average, for reference, is 2.28.

 

Compass Pathways does earn some points with its lack of debt, resulting in a debt-to-equity ratio of exactly 0. This factor could change if the company spends more aggressively than expected and runs through its cash stockpile. For now, though, this absence of debt adds some weight to the bullish argument for the young pharmaceutical company.

 

Based on the available information, it seems reasonable to conclude that Compass Pathways is overvalued, albeit only slightly. The price-to-book ratio is modestly concerning and would become a larger issue if Compass gains as much as analysts project this year.

 

Compass Pathways has a reasonable bullish argument supporting it in the form of its breakthrough therapy designation. This suggests that the FDA will accelerate approval for COMP360. The current near-term price targets seem to assume that this will be the case, creating the possibility for a massive stock rebound.

 

The company plans to operate in a highly lucrative and growing pharmaceutical niche. By 2030, the global market for anti-depressants is expected to be worth over $21 billion.

 

Current estimates suggest that some 300 million people globally suffer from major depressive disorder. Some research indicates that nearly 31 percent of depression cases are treatment-resistant. As such, Compass Pathways could provide enormous value to a large and currently unserved customer case.

 

On the negative side, investors should keep in mind that Compass Pathways is still an incredibly young company that has yet to bring its product to market or bring in significant revenues. As such, it’s a risky company to invest in by its very nature.

 

The combination of higher R&D spending and a shrinking cash stockpile should also give potential investors pause, as it’s entirely possible that the company will burn through its cash earlier than 2024.

 

Running the numbers, we see the stock is overvalued to the tune of 16% with a downside fair market value target price of $14.04 per share. Of course, for a business of this type, cash flows aren’t necessarily the best way to assess intrinsic value. A single approval is more important than historical cash flows.

 

Ultimately, Compass Pathways could be a good buy for highly risk-tolerant investors seeking outsized returns in the pharmaceutical industry.

 

This stock has potential, but its risks are also significant. It’s likely a stock that’s best suited to a small position within a balanced and diversified portfolio. This approach allows investors to take advantage of a potentially asymmetric reward to risk ratio.

 

Conservative investors will likely find the uncertainties of investing in a pharmaceutical startup with no currently approved products too risky. Pharmaceutical startups are notoriously difficult to predict, even when their treatments are useful and backed by solid science. As such, this area of the pharmaceutical industry is usually better suited to investors with an appetite for risk.

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