For a year, shares of Axsome Therapeutics, Inc. (NASDAQ:AXSM) traded in a range of between of between $2.00 to $3.00. That changed on Jan. 7 when the stock rallied by 161%, closing at $6.87. On Jan. 8, AXSM stock is trading hands at $8.22 per share, as of this writing.

Markets reacted to the company’s positive Phase 2 results. The big question for those who missed the rally is: Could AXSM end up like so many other small-cap biotech stocks and drop? To answer that, investors need to dig into the trial results, the potential of a product launch to market and Axsome’s balance sheet health.

Axsome reported results of AXS-05, a study distributing two different doses to patients suffering from major depressive disorder ranging from moderate to severe. Subjects had a 17.2 point drop in the Montgomery-Asbert Depression Rating Scale. The statistically significant superiority over active comparator had a six-week treatment period and involved 80 adult patients.

To put it simply, this is just an orally available combination of bupropion and dextromethorphan.

Market Size for Treating Depression

Investors buying AXSM stock and sending it sharply higher have a good reason to be bullish. The market size of the global anxiety disorder and depression market could reach $18.3 billion by 2023. TAM, or Total Addressable Market, is massive relative to Axsome Therapeutics’ current market cap size of $208.71 million. And this is after the stock’s surge.

TAM is also a fallacy that could trick investors into believing the revenue potential for the company will ever reach 100% of that $18.3 billion. The upside potential is not even gaining a small fraction of that share. The realistic upside for Axsome is getting an approved drug to market and consistently growing the patient base prescribed for treatment.

Professor Maurizio Fava, Harvard Medical School said “Data show currently marketed antidepressants fail to provide adequate treatment response in about two-thirds of treated patients. An estimated 16 million Americans suffer from major depressive disorder each year. As an oral NMDA receptor antagonist with multimodal activity, AXS-05 could provide a new approach to treating this potentially life-threatening condition.”

How The Drug Works

AXS-05 is a glutamate receptor modulator that is thought to help enhance synaptic connections. If communication between brain cells improves, brain levels of key chemicals will go up. This includes serotonin, noradrenaline and dopamine.

Study Results Promising

The study measured patient response through a rating depression rating scale and did not look at any chemical levels in the body or brain. Still, the results allow the company to build on the Phase 3 trial that studies treatment-resistant depression. It also benefits the Phase 2/3 trial of the drug in Alzheimer’s disease agitation.

Financial Risks

Cash balance and cash flow are the two key metrics investors should look at for companies like Axsome Therapeutics. The company raised cash levels in FY 2015 by $48 million. In its most recent September quarter, that cash level fell to $15 million. Axsome made no meaningful revenue from FY 2013, so cash flow from operations was negative. Losses increased steadily in that time, probably due to the higher costs from running clinical studies:

Source: finbox.io

After the market closed, the company announced it raised $23.3 million. This is through a 2.88 million share sale.

Your Takeaway

Axsome Therapeutics is a high-risk play, especially after the stock’s run-up. Shareholders who held the stock for years may sell to lock in the quick gains. And speculators that caught wind of the study’s positive results may trade the stock’s bounce in the next few sessions. With higher volatility ahead, buying the stock now is risky. Yet if buying momentum does not drop and selling is absent, then Axsome could reward traders holding the stock.

The biggest potential headwind for AXSM stock is the 2.88 million share sale. Management clearly capitalized on the stock’s rally to raise funds.

As a value investor in the biotech space, there is nothing wrong with buying only companies that are cash flow positive. This usually means that the conservative investor type would avoid AXSM stock at this time.

As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.