High growth potential and the chances for extraordinary profits in short order are just two of the main reasons investors continue to love biotech micro-caps. Forget Johnson & Johnson (NYSE: JNJ), Merck (NYSE: MRK), Pfizer (NYSE: PFE) and other traditional, large-cap pharmaceuticals companies. Those are your grandfather’s health care stocks and while they have nice dividends, they’re not known for their growth potential and they’re about as exciting as watching paint dry.

Biotech is where the real growth stars lie and it’s not just because FDA approvals can send a micro-cap biotech soaring. Another reason to embrace micro-cap biotech stocks is because this corner of the health care universe is loaded with takeover targets.

Simply put, the best way for large-cap pharmaceuticals companies to bolster their pipelines quickly is through acquisitions. And there’s no more attractive acquisition target than a micro-cap company that can be had on the cheap.

Whether it’s FDA approvals or acquisition candidates you’re after, here are several…

Biotech micro-caps that are worth a close look:

Galena Biopharma (Nasdaq: GALE)

Oregon-based Galena Biopharma trades for less than $2 a share and has a market capitalization of less than $88 million. That would seem to be enough to chase off institutional investors as many mutual funds and money managers are barred from owning stocks that traded for less than $5 or $10. That’s not the case with Galena as institutional investors own about 5% of the shares outstanding.

The company’s marquee treatment is its Neuvax vaccine for breast cancer. Any company with oncology exposure is considered “hot” and if that firm makes a breast cancer treatment, it’s even hotter. Any good news regarding Neuvax could send this stock soaring.

Cadence Pharmaceuticals (Nasdaq: CADX)

One look at Cadence Pharmaceuticals’ chart might be enough to chase most investors away. After all, the stock is down 15% year-to-date and 61% in the past year. That hasn’t scared some hedge funds away from buying the stock. In the first quarter, hedge funds gobbled up 11.4 million Cadence shares, which represents about 20.28% of the company’s float of 56.22M shares, according to Kapitall data. Remember, Cadence trades for less than $3.50, but the average price target is $8.

Immunomedics (Nasdaq: IMMU)

Immunomedics’ lineup includes epratuzumab, a Phase III clinical trial product for the treatment of systemic lupus erythematosus and non-Hodgkin’s lymphoma. It also includes Veltuzumab, a Phase I/II clinical study completed product for the treatment of patients with non-Hodgkin’s lymphoma, immune thrombocytopenic purpura, and chronic lymphocytic leukemia; Yttrium Y 90 Clivatuzumab tetraxetan, a humanized monoclonal antibody for pancreatic cancer that is in Phase Ib/II clinical trial; and Yttrium Y 90 epratuzumab tetraxetan, a Phase I/II clinical study product for patients with non-Hodgkin’s lymphoma.

That sounds like a mouthful, but the New Jersey-based company focuses on cancer and other serious diseases, meaning there might be some hot money in the stock, but any good news from the FDA regarding any of its treatments and Immunomedics will be even hotter.

Obagi Medical Products (Nasdaq: OMPI)

Obagi Medical is different from some of the other stocks on this list for two reasons. First, the stock is in a pronounced uptrend, having surged 25.3% year-to-date. Second, and perhaps more importantly, the company is profitable. In the fourth quarter of 2011, Obagi earned 27 cents a share, nearly double what it earned a year earlier and crushing the 19 cents a share analysts expected.

Obagi is expected to post a first-quarter profit of 20 cents a share on revenue of $28.1 million. The company also has bullish receivables trends. Accounts receivable grew by -13.37% during the fourth quarter ($21.77M vs. $25.13M y/y). Receivables, as a percentage of current assets, decreased from 51.38% to 32.75%, according to Kapitall data.

Bottom Line Considerations

YES…there is a distinct possibility to score huge gains investing in one biotech stock…we all would love to ring up a big winner to brag about. However, very few investors find the one stock that really breaks out. We believe investors should take whatever amount of funds is comfortable for this strategy and divide it among several good choices.

We see a long term healthy demand for biotech stocks, as the baby boomers continue their march toward retirement and continue to develop the same health related issues we are all too familiar with…only at an accelerate rate.

However, the risks in this sector are significant…led by a single fact that many devices, treatments or drugs will never make it to the marketplace…and that may have nothing to do with whether or not they work. Use this brief intro as a starting point and dig into the individual details to see if these four biotech micro-caps make sense to you too.

Posted by Mike Casson                                                                                                                                                                                                                                                                                 Executive Editor