Biotech Stocks: 2 to Avoid, 1 to Buy

Source: Celgene Corp.

Biotech stocks can swing wildly based on drugs in develoment and clinical trial data, and that means the industry is among the riskiest for investors. Figuring out which biotechs are too risky to buy is just as important as knowing which are likely to soar. Here are two companies I believe investors should avoid and one biotech star that could deserve a spot in long-term portfolios.

Shrinking waistlinesMake no mistake about it, Americans have a weight problem. According to the Centers for Disease Control and Prevention, 34.9% of Americans are obese -- and that was based on data from 2011-2012. The nation spends over $147 billion annually treating obesity-related illnesses such as heart disease and diabetes.

Given these numbers, there should be a market for weight-loss drugs such asArena Pharmaceuticals' Belviq. After all, in clinical trials Belviq reduced patient weight by between 3% and 4% when combined with changes to diet and exercise.

However, the market for Belviq has yet to materialize, and there's no clue when that might change. Last quarter, marketing partner Eisai paid Arena royalties of just $3.8 million. That was up nicely from the year-ago period, but it's still an annualized rate of less than $16 million. It remains to be seen whether Eisai's decision to cut prices last quarter to boost prescriptions and win share from competitors Vivus, which markets Qsymia, and Orexigen, which markets Contrave, pays off. Until we find out, there's just too much risk for me to justify buying Arena stock, particularly given that the company lost $32 million last quarter.

Improving heart healthHeart disease is the No. 1 killer in the United States, accounting for nearly one of every four deaths. That's unlikely to change soon given that roughly half of all Americans possess at least one major risk factor for developing the disease.

To combat heart disease, doctors and patients must embrace novel solutions. Given this situation, many thought Amarin Corp. Plc had a big winner on its hands when it won FDA approval of its fish-oil pill Vascepa in 2012.

However, that FDA approval only covered a small population of people with a rare condition known as hypertriglyceridemia. In October 2013, the FDA tabled an application to win approval in a much larger patient population until results from an ongoing and costly phase 3 trial become available -- most likely in 2018.

Since Vascepa sales totaled just $16.5 million last quarter and the company's loss totaled $20 million, it's a coin flip as to when Amarin might turn profitable. Last year, the company's used $72.3 million in net cash from operating activity. Granted, Amarin has a lot of cash on the books, but without insight into the ongoing trial's potential to expand Vascepa's label, this one is just too risky for the average investor to touch.

Dominant playerArena and Amarin both have drugs on the market, but neither has achieved the kind of success that will allow investors to sleep as soundly at night as hasCelgene Corp..

Celgene is one of biotech's brightest shining stars, and it has proven it knows how to successfully develop and commercialize medicine for key diseases.

Its best-selling drug is Revlimid, the top-selling therapy for multiple myeloma. But it also markets Pomalyst, which is a third-line treatment for multiple myeloma, Abraxane, which is a pancreatic cancer drug, and Otezla, which is a therapy for psoriasis.

Celgene's revenue jumped 18% year over year to $7.7 billion in 2014, but what is really impressive is the company's profitability. Last year, adjusted earnings per share grew by 24% to $3.71. The company also sports some of the best financials in the industry, including a cash and investments war chest of over $7.5 billion. Celgene expects its positive sales and earnings momentum will further boost its balance sheet.

In January, the company updated its guidance to include a projection for sales of between $13 billion and $14 billion in 2017. Celgene also believes it can deliver EPS of $7.50 that year. That would be an impressive increase for a company of any size, but it's particularly impressive given how big Celgene is.

Tying it togetherArena and Amarin have developed drugs for important indications, but they are great examples of how blockbuster drug expectations can fall short. Rather than speculating that these two companies can control their spending, deliver trial results good enough to warrant label expansions, and outmaneuver their competitors, a better strategy could be to own Celgene instead. This company has a growing lineup of top-selling drugs, a rock-solid balance sheet, and the potential to nearly double sales and earnings in the coming three years. That's plenty good enough reason for me to embrace it.

The article Biotech Stocks: 2 to Avoid, 1 to Buy originally appeared on Fool.com.

Todd Campbellis long Celgene Corporation. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. The Motley Fool recommends Celgene. 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.