Following an increase in price target from Brean Capital’s Difei Yang, shares of Zogenix, Inc. (NASDAQ:ZGNX) spiked by more than 12% in yesterday’s trading. Yang hiked the price target to $28 from $20 after the company’s successful Key Opinion Leader meeting focused on Dravet syndrome and Zogenix’s treatment for it, an orphan drug ZX008. The analyst felt that the assumptions previously used to value the company were more conservative than they ought to be. For example, the 35% operating income margin for an orphan disease company like Zogenix might have been in line with other specialty pharma companies, but not the orphan drug universe, for which it stands in the 50% range. Moreover, strong long-term clinical data on ZX008 and a lower efficacy bar for the drug owing to the absence of alternative therapies has led the analyst to revise the success rate of pending trials to 80% from 70%.
Hedge funds have been optimistic about Zogenix, Inc. (NASDAQ:ZGNX)’s future prospects for a while. Among the funds that we track, a total of 14 firms had invested about $40.11 million in the company at the end of March as compared to 11 funds with $31.87 million invested at the end of the previous quarter. Zogenix, Inc. (NASDAQ:ZGNX)’s stock price appreciated by a little over 5% during this period, and is up considerably since (by over 80%).
Most investors can’t outperform the stock market by individually picking stocks because stock returns aren’t evenly distributed. A randomly picked stock has only a 35% to 45% chance (depending on the investment horizon) to outperform the market. There are a few exceptions, one of which is when it comes to purchases made by corporate insiders. Academic research has shown that certain insider purchases historically outperformed the market by an average of seven percentage points per year. This effect is more pronounced in small-cap stocks. Another exception is the small-cap stock picks of hedge funds. Our research has shown that the 15 most popular small-cap stocks among hedge funds outperformed the market by nearly a percentage point per month between 1999 and 2012. We have been forward testing the performance of these stock picks since the end of August 2012 and they have returned more than 139% over the ensuing 34 months, outperforming the S&P 500 Index by nearly 80 percentage points (read the details here). The trick is focusing only on the best small-cap stock picks of funds, not their large-cap stock picks which are extensively covered by analysts and followed by almost everybody.
We also track insider activity because it can provide useful insights into the company’s future prospects as seen from the management’s lens. It should be noted that insider purchases are a much stronger indicator than insider selling, which can occur due to a number of reasons and not just a bearish outlook. Hence the fact that no insider sales have been detected in Zogenix, Inc. (NASDAQ:ZGNX) so far this year, while Director Roger Hawley made an insider purchase to the tune of 150,000 shares in two separate transactions this year, gives a strong bullish signal.
Now let us take a deeper look at the hedge fund activity surrounding Zogenix before we pass our final judgement on the stock.