The Next Million-Dollar Penny Stock

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

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:

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.