Xenon Pharmaceuticals Inc. (NASDAQ:XENE) is a biotech stock that has almost doubled in the past month. This is a definition of hot stock in the biotechnology industry, which can be very volatile and heavily driven by news-driven factors. According to MarketWatch, Xenon’s “products include XEN496, XEN1101, XEN901, and XEN007.” And the big, price-driving news lately for XENE stock is about XEN1101, a drug for the treatment of epilepsy.

XENE stock can provide us with a valuable stock market lesson.

On Oct. 14, 2021, XENE stock made a 52-week high of $34.87. Data from Yahoo! Finance shows that the 52-week range for this biotech stock is $9.32 – $34.87. The closing price for XENE stock on Oct. 15, 2021, was $33.66. The lesson I refer to is the different approaches to stock investing — choosing either expectations or reality (i.e. fundamentals).

Most of the time, one of these two investment philosophies drives the stock price, and rarely do both point in the same direction. But when both ways of choosing stocks are in harmony, then this is what is called the sweet spot, the best of both worlds.

XENE Stock: Expectations Are High to Fight Epilepsy

Xenon Pharmaceuticals is a “clinical stage biopharmaceutical company committed to developing innovative therapeutics to improve the lives of patients with neurological disorders.”  The focus is on epilepsy, so when positive news went public on Oct. 4 about the results of clinical trials for XEN1101, XENE stock doubled, closing at $31.50.

The company released a press release that showed the following key findings:

• “The primary objective of the study was to assess the dose response trend of XEN1101 in reducing monthly focal seizure frequency, based on a ranked ANCOVA model. The median percent reduction in monthly focal seizure frequency was 52.8% in the XEN1101 25 mg group, 46.4% in the XEN1101 20 mg group, and 33.2% in the XEN1101 10 mg group compared to 18.2% in the placebo group.
• “XEN1101 was generally well-tolerated in this study with adverse events (AEs) consistent with other ASMs. The incidence of treatment-emergent adverse events (TEAEs) was higher in the treatment groups as compared to the placebo group, with 62.3% of patients in the placebo group, 67.4% of patients in the XEN1101 10 mg group, 68.6% of patients in the XEN1101 20 mg group, and 85.1% of patients in the XEN1101 25 mg group experiencing at least one TEAE.”

These positive clinical trial results will help Xenon Pharmaceuticals to proceed with further clinical development on the road to commercialization of XEN1101. This is the part about the high expectations.

A report about the world epilepsy market mentions that global demand for epilepsy drugs was at $4.6 billion last year and should reach $5.8 billion by 2027, “growing at a CAGR of 3.3%.” The market in the U.S. was around $1.3 billion in 2020, and it noted China, Japan and Canada as other big-growth opportunities in this sector.

The investors are now expecting that Xenon Pharmaceuticals will achieve a large share of this global epilepsy drugs market. But what if the expectations do not materialize? Competition in the pharmaceutical industry is very intense. So even if we are optimistic about the revenue growth of Xenon Pharmaceuticals, we should still look at its fundamentals?

Net Losses and a Public Offering to Support Research

Key factors that move stocks are earnings expected and real growth; the riskiness of the business; and macro-economic factors such as interest rates, unemployment rate, job, and economic growth.

The 2020 Xenon Pharmaceuticals annual report showed revenue growth, reaching a figure of $32.1 million for 2020 compared to $6.8 million for 2019. Most analysts see this as a growth company.

I, however, see that research and development expenses rose for 2020 to $50.5 million compared to $38.8 million in 2019. The operating income is negative, and the majority of cash is only provided by financing activities such as the most recent $345 million public offering.

Ironically this decision to grow and fund the clinical trials of all company’s products seems to be more effective and less pricey for Xenon Pharmaceuticals, as issuing shares is considered to be cheaper than issuing debt. But what is good for the company is not good for the shareholders due to stock dilution.

The second-quarter 2021 financial report showed for the six months ended June 30, 2021, revenue was $6.58 million, much less than revenue reported of $20.46 million for the six months ended June 30, 2020. Net loss per common share widened to 94 cents for 2021 compared to a net loss of 22 cents for 2020. My point, it is too early yet to be optimistic based on real financial metrics.

This is the reality factor. Most biotech companies such as Xenon Pharmaceuticals burn cash, and until they make a true shift to commercialization, they trade at lofty valuations. Xenon Pharmaceuticals is no exception to that rule.

In one of my past articles, I wrote that even moving from phase-2 to phase-3 clinical trials and getting positive results may take years, not months. I want Xenon Pharmaceuticals to succeed, but the reality right now doesn’t support very high expectations. Monitor XENE stock, but buying it at this price is too bold, too risky, and unjustified based on the true financial performance.  Plus, further stock offerings may occur to support further clinical development and trials, and this will not be good news.

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.