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The Big Biotech Rally: More Room to Run?

26 April 2013 in Trading Ideas

The run in biotech stocks is bordering on the unbelievable.

Consider this: in the past 12 months, the S&P 500 has climbed a tidy 15.3%. But biotech stocks, as measured by our own Biotech Breakthroughs motif, a collection of 30 stocks in the biotech industry, have surged 67% in the past year.

And look at the 12-month performances of the motif’s four main stocks that comprise nearly two-thirds of the motif’s weighting: Amgen (20.4% of motif weight) is up 69.3%; Gilead Sciences (18.3%) has jumped 110.3%; Celgene (13%) has climbed 63.8% and Biogen IDEC (11.4%) is up 71%.

For those investing in biotech stocks, or others who figure they’ve missed the biggest chunk of the rally, the concern now is that there’s no possible way the sector can continue to outperform at this pace. Right? Right?

As with any investment, there’s no sure thing, but TheStreet.com’s Adam Feuerstein recently pointed to a JPMorgan research note that makes the fundamental case that biotech stocks may still be undervalued.1

The note, by analysts Geoff Meacham and Cory Kasimov, suggests that the parabolic rise in the price-earnings multiples of biotech stocks isn’t a huge deal because the 2012-2015 compounded annual growth rate for biotech earnings is forecast to reach 18%.

Meanwhile, the projected P/E ratio for large-cap biotech stocks is 14x-16x. That’s right – even after a surge of 70%, revenue and earnings expectations may still be too low.

In fact, as Feuerstein mentions, Wall Street expectations for 2013 earnings performances are actually below what they were for 2012. To the JPMorgan analysts, this sets up a low earnings bar this year, which will be cleared by many of the top names, resulting in the Street raising its expectations for 2013 – and providing another boost to stock prices.

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Further down the road, the analysts point to huge expectations already in place for 2014 and 2015. But as Feuerstein notes, that’s ample time for many of the larger firms to have new drugs in place. Gilead and Biogen, for example, should be up and running by then with their respective hepatitis and multiple sclerosis drug launches.

Of course, that’s also ample time for a stagnating (or worse) economy and labor market to contribute to less-than-stellar profit and revenue results. But for investors who have already enjoyed the past 12 months, it’s not immediately clear where any significant fears of a selloff exist.

1Adam Feuerstein, “Biotech Multiples are Soaring But M&A is Dead,” TheStreet, April 8, 2013, http://www.thestreet.com/story/11889684/2/biotech-multiples-are-soaring-but-ma-is-dead.html, (accessed April 23, 2013).