I write about the small cap biotech space often on Real Money Pro, SeekingAlpha and as editor of Small Cap Gems. One of the frequently asked questions I get is what do I look for when identifying and purchasing “off the radar” small cap stocks, especially in the biotech sector. This is probably due to the huge winners I have identified in this space over the past six months including multi-baggers like Avanir Pharmaceuticals (Nasdaq: AVNR) and TetraPhase Pharmaceuticals (Nasdaq: TTPH).

This makes sense as nothing can provide the returns of investing in a small cap biotech or biopharma company that becomes a much bigger concern in these spaces. Just two decades ago Gilead Sciences (Nasdaq: GILD) was just another small cap equity. It is now a biotech juggernaut whose market capitalization is north of $150 billion and has returned over 14,000% in 20 years (that’s not a typo).

When I scout for under-followed small cap stocks within these areas, I look for a couple of things. I want to see a company I believe is undervalued. I want an entity that can execute well against its game plan and has potentially lucrative growth prospects or could be a buyout candidate given the heavy amount of M&A activity in this space currently. Finally, I need to see a positive catalyst(s) that I feel could be a prelude to the stock going much higher. Here are a couple of attractive plays in this sector that could move up in January on positive events.

I started piling into Conatus Pharmaceuticals (Nasdaq: CNAT) a few months ago when the shares went for around $7 a share. The shares have moved past $10.50 a share but I am still holding on to them. The company’s primary product is Emrisacan which is currently in five Phase II trials to treat various diseases of the liver including chronic liver failure and nonalcoholic steatohepatitis or (NASH). NASH is a very lucrative potential market due to a large segment of the population that eventually will be impacted by it.

NASH causes liver inflammation and the damage caused by a buildup of fat in the liver. It is part of a group of conditions called nonalcoholic fatty liver disease. NASH can cause scarring of the liver, which leads to cirrhosis even in non-alcoholics.

After the bell on Thursday the company plans will report top-line results from three studies in patients with varying degrees of organ impairment. These consist of a Phase II trial in patients with acute-on-chronic liver failure, a Phase 1 in patients with mild, moderate and severe hepatic impairment and another Phase 1 in patients with severe renal impairment. If positive results are provided, it could be a watershed day for the company and the stock.

The company has a market capitalization of under $175 million with approximately $50 million in net cash and market capitalization. If positive results are announced, the company could well find itself the target of a buyout. Gilead Sciences bought a private biotech entity focusing on NASH for some $470 million on Monday including earn outs. Insiders own some 40% of the firm and the median price target on the stock by the six analysts that cover the firm is $16 a share, 50% upside even after the shares recent rally.

Our second small biotech with potential catalysts in the next month is Halozyme Therapeutics (Nasdaq: HALO). Halozyme is a small biotech with a market capitalization of just over $1.2 billion. The company is developing and commercializing enzymes that modify tissue in the extracellular space. Several of its products are being developed in conjunction with bigger partners is the biotech/pharma space including Roche and Pfizer (NYSE: PFE).

In mid-December the company announced that it has entered into a worldwide collaboration and license Agreement with Janssen Biotech, which is the biotech unit for Johnson & Johnson (NYSE: JNJ) for the purpose of developing and commercializing products combining proprietary Janssen compounds with Halozyme’s ENHANZE™ technology which creates compounds to aid in the dispersion and absorption of other injected therapeutic drugs.

The company already has one proprietary drug approved for the U.S. market as well as a couple of products on the market in Europe in collaboration with Roche to extend two of its blockbuster drugs that have come off patent recently. One of the most interesting things about this potential multi-bagger is its mix of new drugs on the market and fairly deep pipeline of promising new compounds.

A potential near term catalyst is a compound named PEGPH20. This drug is targeted at pancreatic cancer. This is a very lethal form of cancer and is diagnosed in just over 45,000 people in the United States annually with almost 40,000 deaths caused by pancreatic cancer in any given year. A person’s chances of developing this form of cancer over their lifetime are around 1 in 70.

Full results will be presented at a healthcare conference in San Francisco next week. The company also plans to start an early stage study for PEGPH20 for treatment of small cell lung cancer soon. The company should garner some $100 million via royalty payments, license fees and milestone payouts in 2015 and already has some $80 million in net cash on the balance sheet.

If the company continues to make progress in the drugs within its pipeline it should become more attractive as a buyout target given the variety of deep pocketed pharma firms that have signed up to use its technology. Insiders bought almost $700,000 in new shares in September which is an encouraging sign as well.

I recently treated my Small Cap Gems readers to a 214.7% gain off a biotech company.

The firm, Avanir, mentioned above, just got bought out and gave Small Cap Gems subscribers a profit of 214.7% in only five months. They got a nice little “bonus” right before the holidays. And I’ve got several several more in the portfolio, with one up 51% in just six weeks. If you’ve been looking for outsized returns from fast growth sectors then you owe it to yourself to read my short briefing. It explains how you can use undervalued stocks, like my biotech recommendations, for life changing returns like the ones that allowed me to retire from my day job in my early 40s. Click here to find out for more.