Healthcare-Focused Investor Believes These Three Cheap Stocks are Poised to Explode

September was one of the worst periods for healthcare stocks and the returns of healthcare-focused investors suffered a lot amid an 11% drop in the NASDAQ Biotech ETF (IBB) and a 16% decline in the S&P Biotech ETF (XBI). One of the investors that registered losses in September is Michael Castor‘s Sio Capital, whose equity portfolio consists entirely of healthcare stocks. In his letter to investors for September, Michael Castor said that his fund lost 3.3% in September, with long holdings offsetting the performance by 10.5% and short bets having a positive contribution of 6.9%. The investor also identified five companies as the main contributors to the negative performance of the portfolio, namely, Aratana Therapeutics Inc (NASDAQ:PETX), Ignyta Inc (NASDAQ:RXDX), HeartWare International Inc (NASDAQ:HTWR), Neos Therapeutics Inc (NASDAQ:NEOS), and Quotient Ltd (NASDAQ:QTNT). Castor significantly trimmed his exposure to two of these five companies, but he is still bullish on the other three.

Let’s take a closer look at the five stocks that had a large effect on Sio’s returns in September and see Castor’s take on them. Sio Capital is one of over 700 funds that we track as part of our small-cap strategy that involves identifying the 15 most popular stocks among these funds. Following the large money managers into their top small-cap ideas has allowed us to obtain returns of around 102% since August 2012, beating the S&P 500 ETF (SPY) by some 53 percentage points (see more details here).

Aratana Therapeutics Inc (NASDAQ:PETX) has been one of Castor’s long-term bets (he has been bullish on the stock since 2013). At the end of June, Castor held 404,738 shares of the pet therapeutics company, having more than doubled his stake during the second quarter. The stock tanked in September, as the company received its first FDA approval for two drugs for the treatment of cancer in dogs. However, both drugs delivered poor results in post-approval studies and the company said that the drugs would not generate any meaningful revenues. However, it was trading 10% in the green before these events and Castor managed to cut most of his exposure to Aratana Therapeutics as the stock approached his target price. The investor still holds a smaller position in Aratana. Most of the other funds we track have overlooked Aratana Therapeutics Inc (NASDAQ:PETX), as only 13 of them reported stakes in the company in the previous round of 13F filings.

On the other hand, Ignyta Inc (NASDAQ:RXDX) remains one of the stocks Castor is bullish on, even though the stock lost almost 20% in the third quarter. Ignyta Inc is engaged in developing novel therapies for cancer and one of the reasons for its stock decline was a lower response rate of its lead compound entrectinib presented in September, as compared with previous results in June. Despite this, Castor believes the company’s entrenctinib will generate revenues and will send the stock higher. Sio Capital disclosed a new stake in Ignyta in its 13F filing for the second quarter, reporting ownership of 522,756 shares. Aside from Sio, 17 other funds from our database reported stakes in Ignyta Inc (NASDAQ:RXDX) as of the end of June, holding over 36% of the company in aggregate, which compares with 12 funds holding shares a quarter earlier.

On the following page, we will present Castor’s take on a stock in which he closed his position, and two others, which remain among his high-conviction picks.

In HeartWare International Inc (NASDAQ:HTWR), Sio did not disclose holding shares in its latest 13F filing and in the letter Castor said that he closed the stake in September as the company announced the acquisition of Valtech, which sent the stock 25% lower. During the second quarter, the number of funds with long positions in HeartWare International Inc went up to 15 from 10, and the aggregate value of their holdings stood at 16.20% of the company, but it is most likely that these numbers will deteriorate in the current round of 13Fs, as many smart money investors probably share Castor’s view on the Valtech acquisition. Phill Gross and Robert Atchinson’s Adage Capital Partners was another shareholder of HeartWare International Inc (NASDAQ:HTWR), owning 1.83 million shares at the end of June.

Finally, Neos Therapeutics Inc (NASDAQ:NEOS) and Quotient Ltd (NASDAQ:QTNT) are two stocks that Castor is bullish on, even though Neos is down by 45% since the beginning of September and Quotient’s shares are down by 22% in the same period. Castor believes that Neos Therapeutics will be able to capture a share in the pediatric market with its ADHD therapies and technology for delivering drugs in the form of pleasant-flavored disintegrating tablets, while Quotient Ltd (NASDAQ:QTNT) will be able to generate revenue once it completes its final FDA validation study in the first six months of 2016. Sio did not disclose holding shares of Neos Therapeutics Inc (NASDAQ:NEOS) in its most recent 13F filing, while it reported ownership of 1.09 million shares of Quotient Ltd (NASDAQ:QTNT) at that time.

Disclosure: None