In my article Investing in Biotech and Pharmaceutical Companies, I describe the recent hardship faced by Arena Pharmaceuticals (ARNA on the NASDAQ) and the resulting severe drop in its stock price from $7 to $2 in a few days in Mid-September 2010. The stock continued to drop from there as investors and speculators tried to find a bottom.

Investing in biotech and pharmaceutical companiesthat have just one drug in their pipeline is extremely risky. They are basically an all or nothing company depending on the FDA's eventual approval of their drug for survival as a corporate entity. If you choose to invest in these types of companies, I will attempt to guide you in the direction where your potential return is maximized for the risk you are taking on.

From July 2010 through September 2010, it was an inappropriate time to invest in ARNA. Speculation was high and the stock had risen from $3 in June to as high as $8 by the end of July and maintained a price over or close to $7 until September 14 when the market first got word that there could be something wrong. From July to September the stock was trading at its highest point since late 2007. It could be several months before the stock finally stops dropping in price and the technical analysis on it indicates that it is a buy. But at some point this will happen.

It is difficult to figure out an exact time and price of when ARNA or other stocks with a similar fate turn around and start to rise. Generally a stock would have found itself stuck in a range for a little while where it is neither dropping nor increasing. At this point they would be trading very close or at their net cash value per share as a biotech stock tends to bottom out when people give no enterprise value for their failed or delayed drug. Net cash value per share is their cash balance less any debt or balance sheet liabilities they have outstanding. Unfortunately ARNA has more debt than total cash outstanding so this will not be a useful way to determine their bottom stock price. ARNA has recently risen from its lows on speculation that the fight with the FDA to approve their drug might not be as onerous as first thought, but there is a great risk that the stock could go lower as none of the technical indicators have shown a reversal to the stock's downtrend.

ARNA will be a good test case to see where its bottom will be hit and how long it will take to turn around. If approval is eventually granted, ARNA will be an excellent example of potential returns possible from investing in a beaten down biotech stock. I recommend that people put Arena Pharmaceuticals on their watch list but wait for proper buy signals before buying.

Looking at other examples, you can determine if the future is as bleak for ARNA as the current situation indicates. My first example is Neurocrine Biosciences (NBIX on the NASDAQ). This stock traded as high as $70 in 2006 and traded over $54 on May 15 of that year. On May 16 the stock dropped to $20 as the FDA did not approve their application to market indiplon tablets for the treatment of insomnia. A series of bad news regarding the drug caused the stock to drop under $8 by October. However, by January the stock climbed back over $13, but the recovery was short-lived. 2007 through 2009 the company faced more hardships and by November 2009 the stock was struggling in the low $2's. But since then, 2010 has been favourable for the company as the stock has risen back over $8. Given the company's history of problems, it would be very prudent for a potential investor to do a lot of research before investing at current relatively high recent prices.

NBIX has had the longest and deepest drop out of all drug developers I have seen and yet it has still seen around a 300% gain from its lows for those who bought at the bottom. This is where an investor who wishes to have a high risk, high return biotech or pharmaceutical stock should focus their research on – looking for stocks that have bottomed out from severe price declines and are looking to turn around. This is very much a technical analysis approach to investing as it is difficult to estimate the worth of the company as their drug's value is so low but is not likely to have a justified value of zero.

My next example is Sequenom (SQNM on the NASDAQ). On April 30, 2009 their stock dropped from $14.91 to $3.62 as their Down syndrome test product had been found to have botched data on its effectiveness. The stock recovered a little bit shortly thereafter but then continued its sell off until it was worth less than $3 during late October of 2009. However, since then the company has been able to successfully release several prenatal related tests made possible by their technology. The stock has recovered, surpassing the $8 mark in early March, tripling from the lows of four months prior. Since then the stock has remained range-bound. Sequenom was an excellent choice because the flexibility of their technology and research allowed them to focus on their next wave of test products.

A stock with a similar potential story to Sequenom is ARYx Therapeutics (ARYX on the NASDAQ). Its stock hit a high of $6 in 2009 and currently sits in the 50 cent range. Its pipeline of products is similar in size as Sequenom so it has the same potential to turn around investor sentiment quickly by releasing good news on one of them. I recommend putting ARYx on your watchlist. It is up to you to do your own research to see if this stock is an appropriate investment for you. As of the date of this article, I do own shares in ARYx.

My final example will be Enteromedics, (ETRM on the NASDAQ). Its stock has recently done a 6 for 1 reverse-split meaning six shares were consolidated into one in order to raise the stock price for NASDAQ listing requirements. Any historical prices I quote will not be the actual prices of the stock at the time but rather the value equivalent of the stock at the time compared to the consolidated stock now. Its current price is around the $2 range and has been around this area for the past 5 months. However, looking back to 2009 this stock once had a $32 price. On October 2, 2009 their Maestro system for weight loss did not meet statistical efficacy endpoints. Meaning, their system did not appear to work any better than a placebo. However, since then there have been questions about the integrity of the study and that the system may indeed be effective. Several pieces of good news have come out for the company, resulting in short term pops of their stock price that tended to fizzle in a few days. However, the price has moved above its 50-day Moving Average, a bullish indicator in the technical analysis world. It will be interesting to see if ETRM has a turnaround similar to SQNM which can be measured in a period of months, or if it is more like NBIX with a turnaround period measured in years. I also own ETRM so I am betting on the former, but everyone should do their own research in determining if this stock is one they should be buying.

As you have seen from my examples, patience and timing are key to making money on beaten down biotech and pharmaceutical stocks. Avoid chasing stocks that are rising in good times and try not to catch a stock on its way down after bad news. It is better for you to wait until it recovers a bit and starts a bullish trend. There are many NASDAQ-listed stocks that are similar to the ones above. Those include DSCO, SNSS, VVUS, MRNA, CTIC, OXGN, CYCC, AFFY, HLCS, XOMA, SVA, DDSS, STEM, BNVI, APPA, PARD, ANPI, NURO, ALXA, ENMD, APRI, BCRX, ACUR and dozens of others. You can see by the size of this list that there are many stocks to choose from that are in a similar situation to my examples above. There is no need to chase any particular one, but rather wait for the right opportunity to come along.

A word of warning when investing in any stock less than $1 on the NASDAQ. The NASDAQ requires that a company's stock be at least $1 in price or else they are in breach of the listing requirement and may be subject to removal from the exchange. This is generally seen as a negative event that will cause downward pressure on a stock price. However, every company is given plenty of warning to rectify the situation and when you do your research you can easily find if a company has been given a warning and how long they have until they either become compliant or get delisted. If a company gets delisted from the NASDAQ they will still be available for trade under the pinksheets. Refer to Generex Biotech for an example of a company that recently got delisted.

There are other great resources for biotech stock trading strategies available on the web.

Refer to my other investment articles if you are interested in learning about:

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