When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at Arena Pharmaceuticals (NASDAQ:ARNA) today, and see why you might want to buy, sell, or hold it.
Founded in 1997 and based in California, Arena is a biotech company most known these days for its weight control management drug, Belviq. Its market capitalization is about $2 billion, and its stock has soared more than 350%over the past year, leading some to wonder if it's still a good idea to buy in, or if it's best avoided now.
The first reason to consider Arena is the business it's in: health care. With our planet's population growing, getting older, and living longer, demand should only grow for medical products and services. Getting a little more specific, Arena's tackling of obesity is also extremely promising, as it affects so many people and is a (ready?) growing problem.
Management is another plus. Arena CEO Jack Leif has been so effective that he was in the running to be our CEO of the year for 2012, and he ended up coming in second overall, which isn't too shabby.
Want growth? Arena's revenue growth has been bumpy, but is picking up. Net losses have been shrinking, as have free-cash-flow outflows. Long-term debt has been dropping, and is more than outweighed by cash.
Another plus is that Arena has partnered with Japan's Eisai (NASDAQOTH: ESALY), to help it bring Belviq to market. That means sharing its gains, but it also likely means more gains to share. (And fewer expenses, as Eisai is paying for additional clinical trials.) Some have speculated that Eisai might even consider acquiring Arena. Meanwhile, as Arena starts targeting more international sales, it recently announced another partnership, with South Korean drugmaker Ildong, to sell Belviq in Korea.
Finally, insurer Aetna (NYSE: AET) has agreed to cover Belviq (and Alli), which will help in sales and acceptance of the drug.
While there's much hope surrounding Belviq, the best situation for a biotech company is to have even more promising drugs coming out of its pipeline. Arena does have a handful of additional formulations in progress, but none are anywhere near the end of the pipeline.
Some companies are more free from competition than others. Arena does have some rivals, such as VIVUS (NASDAQ:VVUS), with its Qsymia weight-loss drug. Approved by the FDA last year, Qsymia got off to a slow start, but sales have been growing. Arena's Belviq, though, is more likely to win approval in Europe first, though, which would give it a strong edge. Competition from Alli (also known as Xenical), co-marketed by Roche (NASDAQOTH: RHHBY) and GlaxoSmithKline (NYSE:GSK), isn't a big worry, as it has had some safety concerns. Orexigen Therapeutics (NASDAQ:OREX), meanwhile, also has an obesity drug in the works, but it's still in trials, hasn't yet been approved, and won't be a threat for at least one or more years. My colleague Brian Orelli has pointed out that Belviq and Qsymia can even coexist, successfully.
Arena's valuation isn't a huge draw right now, as its price-to-sales ratio is around 58, roughly twice its five-year average, close to 10 times the industry average, and more than 40 times that of the S&P 500 (which, admittedly, has much lower growth expectations than Arena). The company's P/E ratio is... well, nonexistent, since there are no earnings to divide price by. While Arena's rising revenue is great, net income is still in the red, though it has been shrinking some. It's reasonable to conclude that much of Arena's great near-term potential is already reflected in its current price.
Rising share count is also a worry, with shares outstanding having nearly tripled over the past five years.
And then there are safety issues, as well as plenty of uncertainty about exactly how well Belviq will sell. Rival product Alli, for example, is sold over the counter, and hasn't broken $1 billion in sales, so it's reasonable to wonder whether a prescription drug will -- especially if each dose costs a few dollars.
Given the reasons to buy or sell Arena Pharmaceuticals, it's not unreasonable to decide to just hold off on it. You might want to wait for its net losses to turn into net gains and for its stock dilution to stop or taper off. You might want to wait for a more compelling valuation, too, perhaps by keeping the company on a watchlist, hoping for a stock-price pullback.
You might also check out some other interesting biotech companies, to see if they seem like better bargains than Arena Pharmaceuticals. Perhaps take a look at Antares Pharma (NASDAQ:ATRS), which is developing innovative drug-delivery systems such as gels and needle-less injections. It, too, has had some dilution and is still posting net losses, despite robust revenue growth.
I'm holding off on Arena Pharmaceuticals for now, largely due to valuation concerns. Everyone's investment calculations are different, though. Do your own digging and see what you think. The company may perform spectacularly in the coming years, but remember that there are plenty of compelling stocks out there.
Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.