When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons and decide whether its possible upside outweighs its risks. Let's take a look at Astex Pharmaceuticals (UNKNOWN:ASTX.DL) today and see why you might want to buy, sell, or hold it.
Founded in 1991 and based in California, Astex is a biotech company that specializes in small-molecule therapeutics and focuses primarily on cancer and hematology. (Before 2011, it was known as SuperGen.) With a market capitalization a little above $300 million, Astex is a small-cap company. Its stock is up about 23% over the past year.
One reason to consider buying Astex Pharmaceuticals is its business. With the world's population growing, getting older, and living longer, demand for health-care products and services is likely to remain in demand.
Another reason to like Astex is its small size. While small-cap companies can be more volatile than their blue-chip counterparts, they can also grow more briskly and have more room to grow -- assuming they execute smart strategies well.
One factor that can help a small biotech company become a bigger one is actually having products on the market -- and Astex does. Its main product is Dacogen, treating myelodysplastic syndrome (MDS). Dacogen sales are expected to slump soon, though, due to its orphan drug exclusivity expiring in May. But the drug's key competitor, Celgene's (NASDAQ:CELG) Vidaza, already lost its patent protection and without generic competition yet, it's still doing well and is approaching $1 billion in sales. Dacogen has also been approved to treat acute myeloid leukemia, or AML.
Another critical factor for biotech companies is their pipeline. Here, too, Astex looks good, with two potential winners -- SGI-110, which targets AML, MDS, ovarian cancer, and liver cancer, and AT13387, which addresses cancers such as non-small-cell lung cancer, prostate cancer, and refractory gastrointestinal stromal tumors. But wait, there's more! Astex has also partnered with some big pharma companies, as small biotechs often do. It's working with AstraZeneca on an experimental cancer drug and with Novartis (NYSE:NVS) on drugs to tackle leukemia and more.
Astex's financial statements offer more things to smile about and a few causes for furrowed brows. Revenue has been steadily rising (averaging more than a 25% annual growth rate over the past five years), but earnings have been falling, partly due to increases in research and spending. Free cash flow has also been shrinking, but has remained positive over the past few years. It has ample cash, too, which has been rising in recent years.
While small caps do have lots of room to grow, many of them don't do so. Astex Pharmaceuticals' stock price, recently around $3.50 per share, is firmly in penny stock territory, where extra-risky companies abound and many fortunes have been lost. It's not a definite portent of doom, but it's a red flag to consider.
Another reason to stay away from Astex -- and other biotech companies -- is that most of us know very little about biotechnology and related fields. Thus, it can be especially hard for us to discern which companies are best poised for success and what the risks are for each. It can make a lot of sense to just steer clear, or to invest in a bunch of biotech companies at once, via an ETF. The iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), for example, can instantly have you invested in more than 100 companies, such as Cubist Pharmaceuticals (UNKNOWN:CBST.DL), which just reported 2012 revenue up 23% over 2011 and EPS up 304%. It has several products on the market and several more nearing the end of clinical trials.
Don't like volatility? Perhaps steer clear of Astex: In 2008, it plunged 48%. In 2009, it soared 37%. In 2011, down 28%. In 2012, up 54%. In 2013, we'll see!
Dilution is another concern, as Astex's share count has surged from about 60 million a few years ago to around 100 million recently. The more shares there are, the smaller each one's stake in the company. Dilution is generally not desirable, but it reflects a company generating more funds, which might be deployed to help the company grow faster.
Finally, Astex's valuation isn't screaming "Buy me!" Its P/E ratio was recently 89, far above its five-year average of 26 and its forward-looking P/E is 28.
Given the reasons to buy or sell Astex, it's not unreasonable to decide to just hold off on it. You might want to wait for it to be selling more drugs or for its income to start growing instead of shrinking. You might also wait for a pullback in its share price to get a bigger margin of safety.
I'm holding off on Astex for now, but I'm intrigued. 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, owns shares of Novartis. The Motley Fool recommends Cubist Pharmaceuticals. 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.