Your Stocks Just Got Riskier

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It's been a busy week for the Food and Drug Administration, and not in the bust-out-the-champagne-we-got-an-approval way. Over the last seven days, we've had:

• a label change for Merck's (NYSE: MRK) Singulair, AstraZeneca's (NYSE: AZN) Accolate, and Cornerstone Therapeutics' Zyflo to include a precaution that the drugs might cause neuropsychiatric events like agitation, depression, insomnia, and suicidal thinking.
• a warning that stolen vials of Novo Nordisk's (NYSE: NVO) Levemir insulin were being sold in the U.S.
• a comment on a publication that suggests the use of attention-deficit/hyperactivity disorder (ADHD) drugs like Novartis' (NYSE: NVS) Ritalin, Johnson & Johnson's (NYSE: JNJ) Concerta, and Shire's (Nasdaq: SHPGY) Adderall and Vyvanse are linked to sudden death in healthy children.
• a warning for Matrixx Initiatives to stop marketing its Zicam Cold Remedy products because of a potential for users to lose their sense of smell.

Compare that to just five safety-related press releases during the entire month of May and it looks like the FDA is getting more vigilant about its duty to protect patients.

The safety-first attitude is great for consumers, but it should cause investors to re-evaluate things a bit. Bill Hemelt, Matrixx's acting president, COO, and CFO, says the FDA didn't give the company any warning that they were going to pull the product off the shelves.

A firestorm of safety?
We'll have to wait and see if the FDA has become more safety-conscious or whether the stars are just aligning poorly for investors this week. There's reason to be concerned that this is the start of something different, though, since the agency has new leadership.

Then again, we've been talking about the agency beefing up safety concerns since Merck's Vioxx was pulled from the market nearly five years ago. The agency has become a little more vigilant about letting the public know about potential dangers, but it hasn't become overly cautious in my opinion. Yet.

Build a little safety into the price
So what does this mean for investors? If the agency is becoming more safety-conscious, investors need to buy stocks with a bigger margin of safety built in. Having a drug pulled from the shelves or getting stricter warning labels is detrimental to a drug company, especially one with only a few drugs on the market, like Matrixx; its stock fell 70% on the FDA announcement.

Larger pharma won't have as much risk, but losing even a fraction of sales of a major product can still hurt -- GlaxoSmithKline's (NYSE: GSK) revenue would have been 1.3% higher had sales of Avandia not dropped by about $600 million after heart problems were reported in 2007.

Even drug developers without any products on the market could be affected if the agency becomes more safety-conscious. The FDA looks at safety in addition to efficacy when it makes decisions about marketing approvals. If it's worried about safety, we may see a decrease in the approval rate. For now, the agency seems to be skirting around the safety issue of new drugs by requiring companies to set up a Risk Evaluation and Mitigation Strategy (REMS) to make sure that doctors are only giving the drug to patients who should be getting it.

To compensate for that increased risk, companies will no longer be able to fetch as high a multiple as they could when the agency was perhaps more relaxed. Investors will need to discount the risk of a rejection for new drugs, lowering the value of development-stage drugmakers as well.

For now, investors need to take a wait-and-see attitude. But make sure you keep a close eye on the FDA and adjust your valuations accordingly.

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