Go with the Promise, Not the Story

03/07/2012 7:15 am EST

Focus: STOCKS

Timothy Lutts

Publisher, Cabot Heritage Corporation

Sometimes it's easy to buy a story instead of buying a stock...make sure you know the difference, and opt for the latter, writes Timothy Lutts of Cabot Wealth Advisory.

A couple weeks ago, there was another announcement about a revolutionary drug. It's the obesity pill Qnexa, which came one step closer to FDA approval when outside advisors voted 20 to 2 in favor of approval.

The developer of the drug is Vivus (VVUS), a little California company that's been around since 1991, but hasn't made a profit in the past decade. But that's irrelevant to the stock's supporters today...who are a far different bunch from the institutional supporters of Eli Lilly (LLY), Pfizer (PFE), and Johnson & Johnson (JNJ).

For one, VVUS was trading under $10 a share just a couple of weeks ago; now it's trading around $23. Volatility has always been part of this stock's story. But for investors who can tolerate the volatility, might it be worth a flyer?

Again, my answer is no...

...which doesn't mean the drug and/or the stock is destined to fail, but that the stock's risk-reward parameters are unacceptable to me, and to all of Cabot's various investment disciples.

First, there's medical risk, which is substantial given that previous diet drugs have been sidelined because of nasty side-effects on users' hearts. Half of Qnexa is phentermine, which gained notoriety as half of the Fen-Phen diet pill, which was pulled from the market because of its links to heart disease.

Qnexa combines that same phentermine with the epilepsy drug topiramate, sold under the name Tomamax. To date, the main side-effects of the combination appear to be dry mouth, tingling in fingers and toes, and constipation. Less frequent side effects include increased heart rate, heart attacks and arrythmias, as well as the possibility of birth defects like cleft lip and palate. Vivus has said it will formulate a plan to ensure pregnant women do not take the drug.

Second, there's company risk. Though Vivus is working on drugs to treat obesity, diabetes, sleep apnea, and erectile dysfunction, the sad truth is that the company has not had a profitable year since 2000.

Furthermore, we note (and we remember!) that from 1995 through 1997, at the same time Pfizer stock was shooting ahead on the strength of Viagra, VVUS was soaring because it had a competing injectable drug for treating erectile dysfunction. The market spoke (the pill was highly preferable to the injection), and VVUS has never been as high since.

Third, there's market risk. As mentioned earlier, the investors in VVUS (to date) have not been institutions; they've been individual investors who are hoping to get rich quick.

The doubling of the stock in the past few weeks has made some of them "rich," but it's also created a new group of owners who bought after the surge, and now impatiently await their profits. What this stock won't be is stable, so for most investors the stock simply carries too much risk.

Now, as a human concerned about the obesity problem in the US, I hope Vivus hits a home run. I hope the side effects of Qnexa are minimal, and I hope other companies piggyback on its success to rein in the epidemic of overweight diabetics in the US.

But as an investor, I know the best prospects for success come by following the tried-and-true investing rules used by Cabot advisories, which lead to exciting (and successful) companies like Equinix (EQIX).

Equinix is one of those invisible companies that make the Internet work, but seldom show their faces to retail users. You can think of Equinix as the landlord of the Internet, in that it rents space and services to a variety of commercial entities.

What those companies get when they locate their servers in an Equinix facility are reliable electrical power, security and access to telecom lines from a variety of providers. They also get the functional advantage of being very close to other providers; for example, Equinix is now advertising that if you place your servers in their Washington, DC facility, you'll have direct access to Amazon Web Services.

Today Equinix hosts more than 4,000 enterprises in 39 data centers in 12 countries on five continents. These include:

  • 7 of the top ten video sites
  • 8 of the top ten Web sites
  • 9 of the top ten advertising sites
  • 5 of the top 5 social networking sites
  • 4 of 5 smartphone platforms
  • 300-plus cloud providers
  • 500-plus service providers

And business is growing! In the fourth quarter, revenues grew 25% to $431 million, and earnings grew 21% to 35 cents per share.

Plus, the chart is strong!

Equinix has been in Mike Cintolo's Cabot Market Letter Model Portfolio for over a month. Subscribers who've followed his advice already have a profit of more than 20%.

Here's what Mike wrote in his initial buy recommendation:

"The stock was one of the first to lift off, which is always a good sign; shares reached a four-year price high last week.

As for the story, the company is attractive to us because of its position at the heart of the Internet; the firm's 6 million square feet of data center space and its various co-location and interconnection services make it the go-to player for companies doing business online.

Cloud computing is helping the cause, of course, but the idea is broader than that—as Internet usage picks up, Equinix is sure to benefit as companies look to expand their networks or speed up their applications.

The business is capital-intensive, and Equinix is still spending plenty of money expanding its data centers. Most of its revenue is recurring (monthly or quarterly payments), resulting in at least 15 straight sequential quarterly gains in the top line."

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