Drop-Dead Gorgeous Stocks

"The idea of buying a former superstar stock at a discount price certainly has its attractions, but you've got to make sure you catch the haft -- not the blade."

That's thesis of my weekly Fool.com column "Get Ready for the Bounce," where I run Nasdaq.com's 52-week-lows list through the "wisdom of crowds" meter that we call Motley Fool CAPS. Out the other end comes a list of stocks that have fallen so far, Foolish investors figure they're bound to bounce back soon.

But is there a way to cash in on fallen angels who've plummeted even further? Perhaps. If a stock that's fallen for one year straight has headroom, then maybe a stock that's fallen even farther, for longer, has room to soar back even higher. In that case, an apparently left-for-dead stock could offer us a drop-dead gorgeous entry price. We'll test that thesis today, starting with five stocks that just hit their five-year lows:

Companies are selected from the "New 5-Year Lows" list published on MSN Money on Thursday. CAPS ratings from Motley Fool CAPS.

Left for dead? Or drop-dead gorgeous?
Each of the stocks listed above has shed between 40% and 90% of its value over the past year alone -- numbers unthinkable before the current economic storm broke upon us. But while Wall Street has left 'em all for dead, Main Street investors are keeping a level head through this crisis. Four of the five are expected to at least pace the market's returns. And CAPS members expect Arena Pharmaceuticals will actually outperform the market.

Wondering why? So am I.

The bull case for Arena Pharmaceuticals
ImRichBeotch wrote a veritable book in defense of Arena back in March. Here are a few highlights:

Currently in the prescription weight loss market patients have 2 options: Xenical or Meridia. Xenical blocks fat absorption in the gut ... The practical end of this is that you have greasy, foul smelling stools that will stain anything they come in to contact with. Nice picture, I know. Meridia works by blocking the reuptake of the neurotransmitters norepinephrine and serotonin ... The downside of this is that increasing norepinephrine can have the untoward side effect of increased anxiety, agitation, and tremulousness. ... This leaves a wide open market for an effective weight loss medication. Arena's lead drug is lorcaserin ... that ... stimulates one subtype of serotonin receptor; that subtype that is located in the satiety center in the brain ... causing you to eat less because you feel full. ... This medication has the potential for blockbuster sales if everything pans out as it is expected to.

Back in June, PhillyDan was:

Feeling very confident that Lorcaserin, Arena's anti-obesity drug will receive FDA approval. The Phase III trials have been going well and the independent monitoring of Lorcaserin shows no signs of cardiac heart valve issues. I expect that Arena will have a strategic partner lined up by the end of this year for Lorcaserin. ... In addition, Arena's pipeline is very compelling with the Insomnia drug now in Phase 2B trials showing well and I expect this to move into Phase III by the end of 2008. If all goes well Arena will have huge upside within the next two years.

Finally, we come to kevin76013. He made what I suspect is a key point back in June, observing that Arena has been "hauled out and shot to near cash value."

A question of cash
When dealing with potential rocket stocks -- a category that covers most tiny biotechs -- you always want to keep an eye on how much the company has, and how quickly that cash is burning away.

In Arena's case, the answers are: "about $272 million" (minus $72 million in debt and capital leases), and "$205 million a year." So it seems to me that Arena has cash on hand to fund its operations for at least a year before it needs to add more debt, or tap the equity markets again. While I'm no expert on biotech, I suspect that gives Arena enough breathing room to negotiate a good deal on Lorcaserin with either of its Big Pharma partners, Johnson & Johnson (NYSE:JNJ) or Merck (NYSE:MRK).

I could see either partner wanting to steal a march on rivals GlaxoSmithKline (NYSE:GSK) and Abbott Labs (NYSE:ABT) in the diet-drug market. In fact, judging from what fellow Fool Brian Orelli told us about taranabant a few weeks back, Merck may be even more eager than usual to do business.

Time to chime in
Our panel of CAPS posters above, and Mr. Orelli, all seem to know Arena pretty well. As for me -- well, if you can find a chimp capable of hurling darts at the Wall Street Journal stock tables, chances are, he knows more about biotech than I do. So please, take my opinion on biotech with a gigantic grain of salt.

Instead, why don't you come on over to CAPS and tell us what you know about Arena. Will Lorcaserin make it to market before the company runs out of cash? Is a buyout in the offing? If you know, here's your chance to show off that knowledge.

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