Is Arena Pharmaceuticals the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Arena Pharmaceuticals (Nasdaq: ARNA  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Arena.

Factor What We Want to See Actual Pass or Fail?
Growth 5-year annual revenue growth > 15% (4.7%) Fail
  1-year revenue growth > 12% 46.9% Pass
Margins Gross margin > 35% 53.3% Pass
  Net margin > 15% NM Fail
Balance sheet Debt to equity < 50% 116% Fail
  Current ratio > 1.3 4.76 Pass
Opportunities Return on equity > 15% (121.1%) Fail
Valuation Normalized P/E < 20 NM Fail
Dividends Current yield > 2% 0% Fail
  5-year dividend growth > 10% 0% Fail
       
  Total Score   3 out of 10

Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; Arena had negative net income during the period. Total score = number of passes.

Arena's score of 3 leaves it well short of perfect. But as with many start-up drug companies, Arena could see things get a whole lot better if its drug pipeline works out favorably.

In Arena's case, that future success relies on a single drug: lorcaserin. The drug helps fight obesity, which has become a popular area of research for a number of drug companies. Vivus (Nasdaq: VVUS  ) has an obesity drug called Qnexa in development, while Orexigen's (Nasdaq: OREX  ) Contrave also targets obesity.

Unfortunately for Arena, lorcaserin hasn't come up a winner in the Food and Drug Administration's approval process. Neither Arena nor Vivus could convince an FDA advisory panel to recommend approval of their drugs, as safety concerns outweighed the potential benefits. Given the FDA's past experience with Abbott Labs' (NYSE: ABT  ) Meridia, which it removed from the market after safety concerns arose, it seemed likely that none of the obesity drugs under development would get through. But Orexigen got a positive nod from an advisory panel earlier this month, potentially opening the door to a huge market if the FDA follows the advisory panel's recommendation.

Despite its rejection, lorcaserin isn't dead in the water. But it's unclear what Arena will need to do to satisfy the FDA. In the meantime, if Contrave keeps its head start, lorcaserin might never catch up -- potentially leaving Arena as another upstart company that didn't live up to its promise.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add Arena Pharmaceuticals to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Fool owns shares of Abbott Laboratories. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


Read/Post Comments (11) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 16, 2010, at 7:53 PM, vigsteven wrote:

    i am a practicing internist.... if all of the weight loss drugs were approved from arena, from vivus, and from orexigen, there is no question that i would first reach for lorcaserin 10mg twice a day in my patients.... efficacy is reasonable and the side effect profile is terrific.. side effects are much less with arena's lorcaserin than the vivus or orexigen drugs for weight loss... .the fda missed the boat by issuing a complete response letter on lorcaserin... breast cancer in female rats at 82 times the human dose is NOT a reason to keep this drug off the market...brain cancer in male rats at 57 times the human dose is NOT a reason to keep this drug off the market... arena likely has met with the fda this week and will likely issue information on arenas plan to respond to the complete response letter by the end of 2010... i expect this drug to be approved by the fda in the summer or early fall 2011...stock is very cheap now and the partnership with eisai is a strong one.... obesity and diabetes is a huge problem in america and the world and doctors need lorcaserin to help fight this battle...

    steven vig md , internal medicine, tucson , arizona

    www.vigformulary.webs.com

  • Report this Comment On December 17, 2010, at 5:51 AM, clawmann wrote:

    Steven, I am not an MD; nevertheless based on what I know of the three candidate drugs, I agree with everything in your comment. I have always thought that the rat cancer issue was truly a red herring, and I am still baffled as to why the FDA combined the tumour data (malignant and benign)to make the issue satistically significant when it is not.

    In any case, I believe that the FDA will eventually correct its position on this (within the next 9 months), and give lorcaserin the approval it deserved in October. If contrave and/or qnexa is approved prior to lorcaserin, I expect physicians to prescribe those until, until, lorc is approved, and then I expect many of those physicians to switch to lorc as the first line therapy.

  • Report this Comment On December 17, 2010, at 8:20 AM, lloyd789 wrote:

    I find it hard to fathom why the author of this piece would print something with the title "Is Arena Pharmaceuticals the Perfect Stock?"

    There are plenty of biotechs with approved medications that would be safer investments if one were looking for something along the lines of a "perfect stock".ANYONE that has experience in biotech knows that this is a high risk investment, especially when it involves a one trick pony.

    I am left wondering why you bothered to write this article with a misleading title.

  • Report this Comment On December 17, 2010, at 9:49 AM, route495 wrote:

    "breast cancer in female rats at 82 times the human dose is NOT a reason to keep this drug off the market...brain cancer in male rats at 57 times the human dose is NOT a reason to keep this drug off the market."

    Unless you are a rat and want to lose weight.

    For others is not an issues.

  • Report this Comment On December 17, 2010, at 10:33 AM, BioBat wrote:

    vigsteven,

    The FDA raised issues that ARNA misclassified many of the rat breast tumors and under represented the actual %s. Having read through ARNAs submission thoroughly, that questions and concerns they raised were plausible.

    On brain cancer, I agree - absolutely not issue whatsoever.

    ARNA may be worth a gamble at its current prices but considering Jack Lief is still running the show, debt is piling up, partnerships are being terminated, and scientific staff has been slashed and burned, it's hard to see how ARNA, even with its deep IP, will make it at all if lorcaserin never gets approved.

  • Report this Comment On December 17, 2010, at 4:12 PM, vigsteven wrote:

    to biorat, the fda complained that the final pathology results were different than the interim results on the rat cancers...however, arena had one pathologist doing the interim reports and the final results reviewed by 3 pathologists... the fda has asked arena as part of the complete response letter to submit a pathology group to review the rat cancer slides, so that review is in progress...

    jack lief is still the ceo, and i believe he is doing a good job despite many forces trying to keep lorcaserin off the market....

    arena should have 150million dollars at year end, more than enough to proceed thru 2011...

    there is no indication that the eisai partnership is being terminated...eisai is a very strong big pharma partner...

    scientific staff at arena is not being slashed and burned...

    i anticipate approval of lorcaserin summer or fall of 2011...

    stock price is up 7% today..

    a great deal is at stake here... literally the health status of 2/3 of americans (who are overweight) and the health of overweight and obese people all over the world.....

    steven vig md internal medicine tucson, arizona

  • Report this Comment On December 20, 2010, at 5:22 PM, GABRIELA1970 wrote:

    I agree with Dr.Vig Steven....

    The ARNA it will be approve next year.....

    Lorcaserin is use in Europe......

  • Report this Comment On December 21, 2010, at 12:11 AM, vigsteven wrote:

    stock price of ARNA up 44% today....12 20 2010...steven vig md

  • Report this Comment On December 21, 2010, at 8:49 AM, rjthompsonmd wrote:

    Lorcaserin as a seratonin agonist, will increase prolactin production from the anterior pituitary. Prolactin will stimulate growth of breast tissue. Please reference, www.pubmed.gov/15856525 and www.pubmed.gov/18709700.

    The lorcaserin clinical trials did not even assess the prolactin levels of trial participants. The FDA AdCom were cautious enough, and rightly so, especially if over one million monthly Rxs for Lorcaserin were written, as were for fen-phen.

    Lorcaserin presents very real risks for women. There are scientific facts, not Arena investor's emotions.

  • Report this Comment On December 21, 2010, at 8:05 PM, vigsteven wrote:

    antipsychotics like risperdal have a powerful effect raising prolactin but risperdal is approved by the fda and not associated with elevated risk of breast cancer... breast cancer in female rats was only seen at 82 times the human dose...

    steven vig md internal medicine tucson, arizona

  • Report this Comment On December 22, 2010, at 4:57 AM, rjthompsonmd wrote:

    The topic is FDA-approval of lorcaserin.

    Prolactin and estrogen stimulate breast tissue. Breast cancer is caused by an oncogenic virus or a genetic mutation (10%) like BRCA1 and BRCA2.

    www.pubmed.gov/19635758 and www.pubmed.gov/20601496

    In 2004, P&G's Intrinsa transdermal testosterone patch for FSD was denied FDA approval because of the aromatization of testosterone into estrogen (50%), and the estrogen stimulation of breast cancer. Lorcaserin will be likewise denied.

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