Mary Long: Keith, psychedelics were, shall I say, once a more niche interest in popular culture, but they've been slowly stepping back into the mainstream in more recent years. This is perhaps in large part due to the fact that clinical trials have found psilocybin, the psychedelic compound found in certain mushrooms, to have potentially therapeutic benefits for a number of mental health conditions: depression and anxiety, PTSD, addiction. You follow this space pretty closely. What are these clinical trials finding, and what questions are they still trying to answer?

Keith Speights: Well, I'll address the second question first, Mary. The clinical trials of psilocybin are trying to answer the same questions that clinical studies for any drug attempt to answer. First, is the drug safe? Second, what's the best dosage to use? Third, is it effective? Now, as to what the clinical trials are finding for this drug, the news has been generally positive so far for both safety and efficacy. For example, there are two companies that are among the leaders in this space: Compass Pathways and Cybin, they've both already advanced their respective psilocybin therapies into phase 3 clinical trials, and that's the last stage of testing before they can seek regulatory approval. To get to this point, both Compass and Cybin have had to demonstrate that their therapies were relatively safe and effective in treating a smaller number of patients, and now they're hoping to show similar results and studies with larger numbers of patients.

Mary Long: For those listening who might be a little more unfamiliar with how the clinical trial process works, could you maybe give us a quick overview of, I know you said that phase 3 is the last phase. What comes before that? What do you have to do to get to phase 3?

Keith Speights: Sure. You have to start off with drug discovery, which that's not a difficult task when you've got a substance such as psilocybin that's been around since mushrooms have existed, but once a drug has been discovered, then companies will get approval from the FDA or regulatory agencies in other countries, they work very similarly. They'll move into what's called phase 1 testing, and phase 1 testing primarily focuses on determining if the drug is safe enough to even advance further along in the process, and they involve a small number of patients, which makes sense because it's that dipping your toes in the water type of stage. Then if they pass that phase, then the drug can move into phase 2 trials. Those trials have more patients, the trials focus on safety and efficacy, as well as determining the optimal dosage of the drug. Then if that is successful, then a company can get FDA's approval to move into phase 3 trials, and that's the last stage that I mentioned. These are larger scale trials. They potentially have thousands of patients involved, and they focus on confirming the efficacy and the safety of the drug.

Now, a drug usually has to move through all three phases before a company can file for FDA approval. Now, in some cases, these are the exceptions where there's a huge unmet medical need, and the agency says we really need to look at approving this drug more quickly than we normally would, then the agency can go with what they call accelerated approval for a drug before it even finishes phase 3 testing, and then they can approve the drug, and then a confirmatory clinical study has to be done after approval. This entire process, Mary, can take years from start to finish.

Mary Long: These clinical trials are many hurdles within themselves. When you're dealing with a substance like psilocybin and psychedelics more broadly, you also you have other hurdles that you've got a crossover as well, one of those just being legality. What is the state of the regulatory and the legal landscape for psilocybin treatments in the US as things stand right now?

Keith Speights: Sure. Let's address the regulatory side first. I think the FDA is taking the same stance with psilocybin as it does with any other experimental drug. Basically, it's telling companies, prove to us that this works, and isn't going to harm patients. The agency must approve all those clinical trials that are conducted in the US. The fact that the FDA has given the green light for several therapies to advance initially into phase 1 clinical testing, several are also in phase 2, and you've got some in phase 3 already. That shows that the FDA is not opposed to psychedelic drugs at all. Probably the most significant development that affects the entire psychedelic drug industry was the FDA's guidance issued last year for clinical trials that evaluate psychedelic drugs.

The biggest thing that stood out to me with this guidance was the agency's emphasis on ensuring that companies put measures in place to prevent the misuse of the psychedelic drugs and that they were addressing the potential psychoactive effects of these drugs: hallucinations, mood swings, that thing. Now, it's important to keep in mind that psilocybin as well as MDMA, which is more commonly known as ecstasy, LSD, mescaline, all the other psychedelic drugs, they're classified as Schedule I by the US Drug Enforcement Administration. Schedule I drugs are deemed as having no currently accepted medical use, as well as a high potential for abuse. There have been legal challenges to the DEA scheduling of psilocybin in particular. Federal court even ruled against the DEA in 2023, but so far, no changes have been made.

That's where the regulatory side stands. As for insurers, I think they're being cautious. That's exactly what you would expect from insurance companies. They're conservative by nature, they want to hold onto their money, so they're taking a very cautious stance. There are a few insurers, including some Blue Cross Blue Shield plans, among others, that cover ketamine therapy in certain cases, they have a lot of restrictions on this. I suspect if psilocybin wins FDA approval, we'll see several of the major insurers step up, offer coverage, assuming the pricing isn't too crazy out of line.

Mary Long: A couple years ago, you saw a lot of interest in the markets in these psychedelic treatments. In 2021, psychedelic start-ups raised nearly $1.8 billion of public and private capital. That's changed. The attitude around this area has changed a lot today. The Horizons Psychedelic Stock ETF, which was once trading on public markets, has since been delisted. There were once dominant players in this space like Atai Life Sciences, Compass Pathways, Cybin, and Mind Medicine. We're going to talk about all those companies in more detail in a few minutes. But all of those have shed more than 60% of their high point market caps. What happened to interest in this space? Where did it go?

Keith Speights: Well, I'll first address the Horizons ETF. Horizon shut down its psychedelic stock ETF, along with a few other ETFs, for that matter. The company didn't just come out and explain exactly why, but it's a really good bet that it was financially motivated. Many of the stocks in the ETF, including the ones you mentioned, have plunged a lot since mid 2021 or so. Now, there have been some negative developments that accounted for a lot of that decline. For example, Compass Pathways phase 3 study of COMP360, which is a psilocybin therapy. It's taking a lot longer than anyone expected, including the company. Compass even acknowledged it's learning just how complicated, these larger scale clinical trials can be. It's a learning curve for these companies.

I think the main reason behind that steep decline that you mentioned though is that there was just simply too much hype about psychedelic stocks a few years ago. Stock valuation skyrocketed much higher than was warranted, and we've seen reality set in. It takes years to get a drug approved and hopefully onto the market, and I think the decline that we're looking at now is just investors realizing, we got the cart before the horse with these stocks.

Mary Long: Help me understand the business model for a lot of these companies a little bit, because psilocybin, psychedelics, they're naturally occurring substances. They can't be compounded and sold, you can't put a patent on LSD as a company and say, that's mine, I made it. How does that factor into the approval process that these companies are going through and developing their therapies, and then down the line, if they get that approval, their business plans?

Keith Speights: Drug makers can get very creative, Mary. Psychedelic drug companies are taking an approach that many other pharmaceutical companies have done that aren't in the psychedelic space. They're filing for what are called composition of matter patents, and these patents cover the structure and formulation of a substance. What they're doing is they're tweaking how they make these chemicals. Cybin, for example, a company we've mentioned, it has 70 of these composition of matter patents worldwide or patents similar to that. The company has 220 patent applications pending worldwide. We're talking about a lot of patents. Compass Pathways is following a very similar strategy, they have over 20 patents for COMP360. A lot of those are composition of matter, but then some of them are related to the company's manufacturing methods. They're looking at every angle they possibly can to get some intellectual property protection here.

Mary Long: This space was recently in the news, if you're following it closely because of a recent FDA denial of Lykos Therapeutics' MDMA therapy. This was specifically targeting PTSD. The company also had several articles pulled from the psychopharmacology journal due to "unethical conduct." What's the impact of this negative news swirl around Lykos Therapeutics on the broader industry right now?

Keith Speights: We were talking about this steep sell off over the last few years. This is another factor that played into the general decline of psychedelic stocks. Now, to be clear, the FDA really didn't put up a roadblock for MDMA itself. However, the agency absolutely hammered Lykos Therapeutics on its clinical trial design, and rightfully so. Now, I think this underscores what's a key issue for this industry. None of these companies have navigated the regulatory pathway before. It's all brand new to them. They're finding out how difficult it is to design and conduct clinical studies in the rigorous manner that the FDA requires to win regulatory approval, and we're seeing the learning curve for these companies, and it's had an effect on the industry and on stock prices.

Mary Long: One of the problems with these studies and trials is that you can't really do a double blind with a psychedelic. There's a big difference between a placebo and a psychedelic compound. Where do these companies that are thinking through that go from here? Do they need to rethink, or do we perhaps more broadly, need to rethink how we test drugs and medicine to make a pathway for these drugs?

Keith Speights: You raise a really great point about a major challenge with testing psychedelic drugs. A double blind clinical study is the gold standard for clinical testing. Now, double blind means that neither the patients nor the researchers involved in the study know which patients are receiving the experimental drug or which of them receive placebo. This double blind approach gives more statistical confidence in the study's results. But as you mentioned, a double blind study just doesn't work with psychedelics because patients would know whether or not they're experiencing any psychoactive effects, and so they would know whether or not they were in the group that's receiving the psychedelic drug or whether they're in the control group receiving placebo.

This is a unique issue that doesn't impact most other drugs. Now, there are some approaches that could be used and some are being used. For example, different groups can be given different dosages of the psychedelic drug, and so maybe the group with the lower dosage will experience little bit of psychoactive effects to make them think, I'm not receiving placebo, but not enough that the actual group that the company is really targeting is receiving. Another possibility is just to use a different psychoactive drug in the control group. In fact, in the FDA's guidance for clinical trials for psychedelic drugs that were issued last year, this was one of their suggestions that could be a possibility.

Mary Long: We've talked about this run up in interest in psychedelic stocks that we saw peak in 2021, that's since pretty severely subsided. Another adjacent industry that's experienced a similar rise and fall is the cannabis industry. Does the cannabis market pretend anything for psychedelic stocks and what comes next?

Keith Speights: I really don't think so. The reason why is these markets are so different, the cannabis market, it's like a commodity market. Most cannabis products don't go through the FDA regulatory process for one thing, so that makes it very different from what we're seeing with psychedelic drugs. Many of the problems we're seeing with the cannabis industry and the reason behind cannabis stocks performing so poorly over the last couple of years or so are related to supply and demand. When there's too much supply, prices fall, and they cause the cannabis company's revenue to decline. This won't be an issue, I don't think, in the psychedelics market, because if psychedelic therapies win FDA approval, then the companies will start marketing the drugs and we'll see things go along that path, more of a traditional drug path to commercialization, which is much different than we're seeing with cannabis.

Mary Long: If I'm listening to this show and I'm thinking, this is a pretty interesting space, interest more broadly has waned. Let me take a look at some of the companies that are playing here. How might I distinguish a psilocybin treatment from Company A from another treatment made by Company B? We talked before, they're all working with similar, naturally occurring compounds. How can we look at what one company is doing and how that's different from another company that's playing in the space?

Keith Speights: Sure. Well, different companies are taking somewhat different approaches. For example, Compass Pathways, one of the companies we've mentioned, they're developing COMP360. It's a synthetic psilocybin that's manufactured in a way that ensures consistency. They're not extracting a chemical out of a mushroom, they're synthetically manufacturing. Then you've got Cybin. Their lead product is CYB003. It's a deuterated psilocybin. That means the hydrogen atoms in the molecule are replaced with deuterium, which is heavy hydrogen. This makes its effects have a shorter duration, and that in turn makes it better suited for therapeutic use. These companies are taking different approaches. As we discussed earlier, the companies also try to differentiate their formulations, and sometimes they're manufacturing methods just enough so that they can try to win that all important patent protection.

Mary Long: What's the long-term dream and hope of these companies from a business perspective? Is an ideal path that they are ultimately acquired by a pharmaceutical company? Do they want to build out revenue comparable to that seen by pharmaceutical companies? Looking years down the road, what does, let's just say Compass Pathways want to be in the future?

Keith Speights: Sure. First of all, I would say, I would suspect that the management and board of Compass Pathways wouldn't be opposed to being acquired whatsoever if the price was right. That's probably true of any small drug maker. But all of the companies we've talked about, I think have similar business plans as pharmaceutical companies that make drugs that aren't psychedelic. First, they hope to win regulatory approvals in the US and ideally in other countries as well.

They want to secure coverage from private insurers, from Medicare, from Medicaid, they'll need to field sales teams to market their drugs to physicians, and some of them will probably want to launch direct to consumer marketing campaigns like other drug makers do, and like other pharmaceutical companies, they'll want to use the revenue made from the sales of these initial drugs to invest in research and development or perhaps their own acquisitions and licensing deals to build out their pipeline and do it all over again. Now, again, if along the way, they attract enough interest from a bigger player and there's a great offer, I'm sure you would see companies like Compass Pathways and Cybin, MindMed, any of the others. I'm sure you would see them absolutely entertain an acquisition offer if one was made.

Mary Long: Let's take a minute to zoom in on some of the companies that are bigger names in this space and get a sense of where they are today and how they stack up to each other. I'll curvy this before we dive in by saying, a lot of these companies have pretty low market caps, especially relative to where they were at their peak a few years ago. Everything that we're talking about here is more just informative, landscape level stuff rather than we're not necessarily trying to highlight any of these as potential investments quite yet. Let's kick things off with atai Life Sciences. They've got eight programs in clinical testing right about now. Are any of these programs particularly interesting and exciting to you?

Keith Speights: Yeah. I think the program to really watch with atai is RL-007. Now, the thing that stands out about this drug is it's not psychedelic. RL-007 is a neuromodulator. That's a chemical that modifies the activity of neurons in the brain, but it's shown some potential to improve cognitive function. Although it's not a psychedelic, atai does have psychedelic drugs in its pipeline, I think this is really the program to especially watch. Atai also owns a majority stake in Recognify Life Sciences. It's actually the company that's developing and evaluating RL-007. It has testing underway in a phase 2 study that's targeting cognitive impairment associated with schizophrenia. Initial results are expected from the study in the middle of 2025, so it's not going to be too terribly long before we have some information about this. That's the program for this particular company that I would especially watch.

Mary Long: I'm glad you mentioned that atai has this majority stake in Recognify Life Sciences because they also have a minority stake in a competitor of theirs, Compass Pathways, which we'll talk about more in a moment. Is partnership the right word? Is that pretty normal in this space?

Keith Speights: It's really hard to say what's normal for this space because the psychedelic space is just so small that atai is an exception with its stake in compass. But just broadening the picture, it really is common for pharmaceutical companies in general to invest in other smaller drug makers. I will say, Mary, though, what's really unusual about this particular case. Atai's market cap is smaller than Compass Pathways' market cap, that's quite unusual.

Mary Long: Compass recently underwent some layoffs, they let go of about 30% of their workforce. As somebody who's watching this space, does that indicate anything to you about a potential realignment at the company? If so, how are you feeling about this potentially new direction and what that direction might be.

Keith Speights: Those layoffs are really just a direct result of first of all, Compass' cash position. These companies burn through cash. Also very importantly, the delays that we've already talked about a little bit in the phase 3 testing of COMP360. Basically, what Compass is doing is shifting its entire focus on getting COMP360 to the finish line. The layoffs, which by the way include cutting some senior management positions should enable the company to fund its operations into 2026, and that's good news. I do think these kinds of strategic reorganizations usually reflect that management has dropped the ball somewhere along the way, and I do believe that's the case here. But they're sometimes necessary. In Compass' case, I think it's probably the best move for the company to make at this point. It does put them in the position it needs to be to advance COMP360 through the phase 3 studies, hopefully into winning regulatory approval of the drug.

Mary Long: One of the tricky things about all the companies that are playing in this space is that all their programs are still in development, as you've mentioned throughout this conversation. Because of that, there's no real recurring revenue for these companies to handle. All of these treatments are still likely years away from genuine large scale commercialization. What advice do you have to investors who are interested in the promise of these treatments and itching to put some money into this industry? How do you evaluate these companies from a financial perspective if you fit that bill?

Keith Speights: First of all, I would emphasize investing in psychedelic drug stocks is no different than investing in anything else. It's all about balancing risk versus reward. Because these companies don't have products on the market, their risk levels are understandably much higher. My advice to investors is to just be fully aware of those risks. There's no guarantee that any of these companies will be successful. Because of that, the size of your position that you might invest in these stocks is paramount, because they're highly risky, don't put money in any of these stocks that you're not willing to lose. I also just mentioned a risk management strategy that applies to biopharmaceutical stocks in general. If you're really excited about the potential of a given company's experimental drugs, their candidates, great.

Consider investing a small amount when the programs are in phase 1 testing. If they then clear that hurdle and advance into phase 2's testing, maybe increase your investment a little. If the drug then advances into phase 3 testing, up your investment a little more. If it proves to be successful in phase 3 testing, you could add even more because then much of the risk has gone in terms of getting the market. Each step along the way reflects a reduction in risk. That's not a bad strategy to take with these psychedelic stocks or any other biotech stock or pharma stock that is a clinical stage where it doesn't already have products on the market generating revenue.

Mary Long: We were talking before we started recording about the ups and downs in this space and how interest has really waned since its peak. What is your outlook of this industry more broadly moving forward?

Keith Speights: I will say there's still a lot of risk, but we do have a handful of companies that have programs that are in phase 3 testing, that last stage of clinical testing. I think a lot of the risk has been removed, not all of it, but a lot of the risk has been removed. If those late stage tests go well, then I think you're going to see renewed interest by investors into this space, because investors want success, that's it. Once they see positive developments from these companies, there's been a lot of negative developments over the last couple of years, they start to see some really good positive developments and start to see some of these psychedelic drugs get close to that finish line of winning FDA approval and getting onto the market. That's going to reignite investors excitement in this space. I think you're going to see possibly anyway, several of these stocks rebounce significantly over the next, let's say, 2-3 years.

Ricky Mulvey: As always, people on the program may have interests in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. The Motley Fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.

Keith Speights has no position in any of the stocks mentioned. Mary Long has no position in any of the stocks mentioned. Ricky Mulvey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Is Your Mind Ready to Consider Investing in Psychedelics Stocks? was originally published by The Motley Fool