The Next Million-Dollar Penny Stock

Penny stocks can make you rich. Need proof? Every one of these multibaggers was once a penny stock:

Company

Recent Price

CAPS Stars (out of 5)

5-Year Return

China North East Petroleum (NYSE: NEP  )

$8.78

*****

1,070.7%

General Steel Holdings (NYSE: GSI  )

$3.89

*****

289.0%

BioMarin Pharmaceutical (Nasdaq: BMRN  )

$22.78

****

376.6%

American Dairy (NYSE: ADY  )

$20.38

****

324.6%

SIGA Technologies

$7.11

**

364.7%

Sources: Motley Fool CAPS, Yahoo! Finance.

The promise of outrageous returns has periodically made even the world's best stock pickers penny stock investors. Peter Lynch has enjoyed the stock market's super-cheap seats in the past, and still does on occasion. The Royce Low-Priced Stock fund has beaten the market for a decade by betting on stocks trading near or below $10 a share, including GrafTech International (NYSE: GTI  ) .

Even the All-Stars in our 160,000-plus Motley Fool CAPS community take to penny stocks. More than a few have been richly rewarded.

Pennies from heaven
So why not invest in penny stocks? Well, the warning the SEC issued about them provides one excellent reason to steer clear. But what if we take the agency's definition literally, and limit our choices to stocks trading between $1.50 and $5 a share? And what if we further seek only four- and five-star stocks with a market cap between $250 million and $2 billion? Surely our CAPS screener would return some winners, right?

This week when I ran that screen, 56 stocks made the cut -- including our last topper, TransAtlantic Petroleum.

My favorite penny stock this week is Arena Pharmaceuticals (Nasdaq: ARNA  ) , a biotech whose drug innovations include the obesity treatment lorcaserin. The details:

Metric

Arena Pharmaceuticals

CAPS stars (5 max)

****

Total ratings

538

Percent bulls

94.4%

Percent bears

5.6%

Bullish pitches

101 out of 104

Timing makes Arena more interesting than it otherwise might be. If that sounds odd, it should; we Fools tend to frown upon market timing. Trouble is, as investors, we all exercise some amount of market timing when we make investing decisions. Decisions that say, ostensibly, "now's the time to invest in this stock." Now could indeed be the right time to invest in Arena Pharmaceuticals, because obesity is that big a problem.

But don't take my word for it. Jeffrey Koplan, a director for the Centers for Disease Control, calls obesity in America an "epidemic." Recent studies say that more than 300,000 premature deaths each year are due to a combination of excess weight and physical inactivity.

Statistics like these help to explain why first lady Michelle Obama has taken the fight to flab with a campaign she calls "Let's Move," which encourages children to embrace healthier foods and regular exercise.

Surely we can agree that working up a sweat is the best remedy for those wishing to shed a few pounds. For those dangerously overweight and at risk for a heart attack or other serious disease, Arena's lorcaserin could offer help if approved by the FDA.

Yet there are skeptics, including Brian Orelli, a Foolish colleague and student of biotech stocks such as Arena. "There's a market [for lorcaserin] if it's approved, but I really have no idea how the FDA will decide about any of the three," Brian told me recently, referring to lorcaserin plus competitive options from VIVUS (Nasdaq: VVUS  ) and Orexigen Therapeutics.

"Arena probably has the best side effect profile, but the weight loss isn't anything to get excited about. The FDA will balance the two when deciding," he said. A decision is due by October.

If I'm more optimistic, it's because Arena has yet to secure a major partner for selling lorcaserin. CEO Jack Lief recently told Reuters that his company is preparing to sell the drug on its own if no partner is found -- which led to a sell-off in the stock price -- but I don't believe it will come to that. Someone's going to sell an obesity treatment, assuming it gets approved, and Big Pharma is going to want its cut.

Now it's your turn to weigh in. Would you buy Arena Pharmaceuticals at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate. You can also weigh in using the comments box below.

Each month, our Motley Fool Hidden Gems service spotlights promising micro-cap opportunities in a segment called Tiny Gems. Try this market-beating service risk-free for 30 days to find out what our penny stock sleuths are following now. BioMarin Pharmaceutical is a Rule Breakers recommendation. General Steel is a Global Gains pick.

Fool contributor Tim Beyers is also a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool owns shares of GrafTech International and is also on Twitter as @TheMotleyFool. Its disclosure policy was small and cuddly. Once.


Read/Post Comments (3) | Recommend This Article (13)

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 March 23, 2010, at 10:51 AM, TMFKris wrote:

    I don't know about the company, but an anti-obesity drug should be successful if:

    1) Insurance covers it.

    2) There are enough people willing to live with the side effects. People are more apt to tolerate side effects if they have a lot of pounds they want to lose.

    3) If it leads to significant weight loss (not just a couple of pounds), which might have a positve effect on health and appearance.

    4) It can help keep the weight off over time. If it proves, like diets, to be unseccessful at this, potential new customers might not be willing to pay for it.

    Kris (TMF copyeditor)

  • Report this Comment On March 23, 2010, at 4:32 PM, malcifar wrote:

    I feel this is a good buy at current market price. As we move closer to 10/22 (FDA approval date), the stock will slowly continue to rise on spec alone, especially if they secure a partner to market lorcaserin. I predict a price in the $5-$6 range at that point. If they get approval, I can easily see an instant jump to as much as $10-12 a share. Then, if Vivus' offering is rejected by the FDA when it comes up 6 days later (10/28), it will put Arena in a very favorable position in a market with the potential for $1-2 billion in annual sales. This could make Arena a $20+ stock based on market cap.

    On the other hand, a rejection by the FDA will make this a less than $2 stock.

    The good: Strong safety profile. Something as "non-vital" as a diet pill will need an extremely strong safety profile with no severe side effects to have any hope of getting approval. lorcaserin seems to fit that criteria.

    The bad: 1) Not as effective at weight loss as competitors offerings (though offerings from vivus and orexigen have more side effects making approval more difficult). 2) The FDA has not approved a new prescription diet drug in the past decade.

    Conclusion: Very worth it at this price. Sell off a chunk when it rises on spec (hopefully $5-6 a share) and hold the rest for the FDA decision. Don't hold more than you can afford to lose, as a rejection will send it plummeting to $1-2 a share.

  • Report this Comment On March 23, 2010, at 5:49 PM, SoCal90046 wrote:

    I think that the FDA will give marketing approval for lorcaserin--the diet drug discovered and developed by Arena. It's met all its endpoints. The phase III results were successful: the drug completed the study as required by FDA. Lorcaserin seems to have a safer profile than competing potential therapies, which should put it in a good position. Finally, if both lorcaserin and the offering from Vivus are approved, I don't see it as being a problem. I suspect that Arena (or its future partner) will attempt to convince doctors to prescribe lorcaserin first; Qnexa (Vivus) could be a fall back if the patient fails to respond to lorcaserin.

    I think that Arena poses an excellent buying opportunity right now.

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