Time to Buy Biotech?

June 17, 2016

The biotech industry has taken a beating and dropped about 35% since its peak last summer as many investors have come to regard it as too speculative and risky. However, a contrarian view indicates that the Nasdaq Biotech Index is trading at a discount relative to its historical price-to-earnings and price-to-book ratios, and now may be an attractive buying opportunity.

Charted, we see the recent dip in Nasdaq-listed biotechs, though earnings have recently recovered and book value has steadily grown since the beginning of the biotech rally. The majority of the book value growth has been in intangible assets indicating that companies are expanding their patent arsenal. This buildup of intellectual property is a positive sign given the increased expenditures in research & development. Though only a few of these advancements will come to fruition in the marketplace, the thought is that those that make it will pay off handsomely for investors.

While fundamentals appear steady, investor skepticism is beginning to impact fundraising. Only $483 million has been raised via 8 biotech IPOs through May of 2016 while over $2 billion was raised via 17 IPOs during the same time period in 2015. Larger and more financially stable firms, such as Celgene, have capitalized on lower valuations through share buybacks. Smaller firms seeking cash to develop their pipelines, however, may begin to suffer if the sentiment of investors does not change. For now, the current ratio of this index has remained stable, indicating that there is no near-term liquidity problem for the industry.

Ultimately, the industry retains great potential. Drugs are shifting from blanket treatments that may only be partially effective for a mass population to specialized approaches for smaller populations with significantly increased efficacy. This increases revenue opportunities as a few specialized treatments are now regularly combined for a more potent approach. In an age when manipulating a genome is commonplace, revenue and earnings growth potential is seemingly unbounded. Though many of these technologies may prove unviable, investor sentiment for the industry may be overly negative given current valuations, stable fundamentals, and the sea of promising advancements available in the field.