Let me start off by answering my question of whether or not shares of Arena Pharmaceuticals (NASDAQ:ARNA) are too high; the answer is no, although it will be very interesting heading into the company's FDA decision. In the last month shares of ARNA have increased by more than 80%, and are trading higher by over 420% since the start of 2012. The reason for its most recent rally during the last week is because the decision date for its weight loss drug lorcaserin is expected on June 27, and after a recent panel recommendation, many investors are expecting an approval. An investor has to look at the gains so far this year and factor that into their buying decision. A panel recommendation doesn't always become an approval, as holders of Chelsea Therapeutics (NASDAQ:CHTP) recently learned. I am long ARNA but realize the near term risk involved.
According to the Centers for Disease Control and Prevention (CDC), the number of obese people in the U.S. has continued to rise, and is now more than one-third (35.7%) of adults. It is also estimated that nearly $150 billion was spent on medical costs associated with obesity in the U.S. Therefore, this data suggests that there is a massive need for a weight loss drug such as lorcaserin. Considering the estimated market for weight loss products in the US alone to be $61 billion, lorcaserin could be an immediate blockbuster.
Despite the fact that I believe the drug will be approved, and will become one of the most profitable and prescribed drugs in America, as investors we must look at all possible situations to determine an investment. The stock trades with a market cap of more than $1.80 billion, which under normal circumstances I would say is way too high for a company going before the FDA for marketing approval. If for some reason the drug is not approved, this is a stock that could easily see downside in excess of 50%, therefore creating the question - is the risk worth the reward?
The drug has already been recommended for approval, therefore its chances of being approved are very high. At this point the market is expecting an approval, which means gains may already be priced into the stock. Then again, this is a drug that could return billions in sales, meaning the upside for this stock is far greater than its current price.
I think that those buying shares in ARNA and trying to capitalize on its gains need to consider the risks. It is very possible that ARNA trades lower the day(s) prior to the FDA decision, as some investors take profits. It is also possible, although unlikely, that it will not be approved on June 27, thus creating selling pressure.
Overall, the company can now see the light at the end of a very long tunnel, it has a partner ready to commercialize, and the potential returns for investors are large. I would expect volatility, leading up to and then following the FDA decision. The stock is overbought and I think a lot of investors are attempting to swing-trade ARNA and aren't considering the volatility that may arise in the days prior to approval. My suggestion, if you believe in an approval, is to go long and forget about the stock. The company may see some bumps in the road over the first year, as most biotechnology companies experience shortly after marketing approval. Going long will allow investors to capitalize on a company with unprecedented upside over a period of many years. I view a position in this stock in two ways: You can either buy now and hope for a 10% pop (but also may lose due to profit taking) or you can buy and forget and capitalize on a potentially $10 billion company in the next five years, if lorcaserin lives up to expectations. In my opinion, the best way to play ARNA is to be long.
Disclosure: I am long ARNA however I recently sold off much of my position. I still own several thousand shares.