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After Spring Lull, Biotech Is Back On a Tear

19 July 2013 in Trading Ideas

There’s no rest for the wicked – or for those investing in biotech stocks, it seems.

The industry’s performance so far in 2013 is virtually unmatched. As the Wall Street Journal reported on Tuesday, biotech stocks, as a group, entered this week up nearly 47% this year, ranking it third among 160 different industries in the S&P 1500 Index.1

This performance has also been echoed by the Biotech Breakthroughs motif, which is up 39.7% so far this year. The S&P 500 has increased 15.8% during the same period.

Biotech Breakthroughs Biotech companies have enjoyed a bevy of tailwinds this year that have helped fuel the rally. As Reuters recently noted, a favorable regulatory environment and lower capital costs have been solid foundations of support. The US Food and Drug Administration approved 39 drugs last year – a record beaten only in 1996. Deutsche Bank, meanwhile, has estimated that interest costs for large-cap biotechs to borrow in the capital markets are about 2% lower today than in 2007, and are likely to remain there for several more years.2

And let’s not forget the little notion of high-end earnings growth. As Baird analyst Christopher Raymond told the Wall Street Journal on Tuesday, consensus forecasts are predicting that large-cap biotech companies could post 20% earnings-per-share growth over the next several years.

As the Journal explains it, that need by fund managers to align with such a high-growth sector is why fund managers have found themselves back in biotech after the industry rallied from a spring pullback.

However, some investors are no longer seeing all biotech stocks as created equal. Raymond said he believes large-cap biotechs are perhaps a little stretched valuation-wise, a sentiment echoed by FAI Wealth Management research director Curt Gross, who believes the valuation of small- and mid-cap biotech names is more appealingly valued when comparing overall valuations vs. expected spending on research and development.

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As we noted last week, small-cap drug and biotech stocks have been a main driver of the substantial outperformance of small-caps overall, compared with large-cap stocks over the past two months.

On the other hand, smaller biotech stocks come with their own heightened risk propositions. As Gross told the Journal, “In biotech, either your company hits its mark in clinical trials and your company is now worth 100% more than before, or you miss the mark and its value sinks 80% in a very short period. This is a very risky business.”

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1Murray Coleman, “Advisers Handle Hot Biotech Stocks With Care,” WSJ.com, July 16, 2013.

2Deena Beasley, “Analysis: Biotech’s bull run starts to look frothy,” reuters.com, May 28, 2013, http://www.reuters.com/article/2013/05/28/us-biotech-stocks-analysis-idUSBRE94R0CL20130528, (accessed July 16, 2013).