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Summary

  • The biotech sell off has affected the best of them: the top 10 FBIOX stocks fell 16% in the month of March.
  • While P/S, a misnomer for market cap-to-revenue, gives a only a snapshot valuation, it is one way to compare stocks and to look for inflation of valuations over time.
  • Valuations of most of the FBIOX top 10 had not become inflated between early 2012 when prices began to soar, and late February 2014 when the sell off began.

When prices go exponential traders expect them to fall. The biotech industry as represented by Fidelity Select Biotechnology Portfolio (FBIOX) started to climb almost exponentially in early 2012:

(click to enlarge)

Then, during the one month between the February 27 and March 28, 2014, FBIOX fell by 18%. Even the top 10 holdings of this diversified biotechnology fund with nearly 190 stocks, fell by 16%. Price decline for the individual stocks are listed here (list from Google Finance on March 28):

Price Change for Top 10 FBIOX Holdings

Gilead

(NASDAQ:GILD)

-18%

Amgen

(NASDAQ:AMGN)

- 2%

Biogen

(NASDAQ:BIIB)

-14%

Celgene

(NASDAQ:CELG)

-14%

Alexion

(NASDAQ:ALXN)

-19%

Intercept

(NASDAQ:ICPT)

-25%

Vertex

(NASDAQ:VRTX)

-18%

Regeneron

(NASDAQ:REGN)

-11%

Medivation

(NASDAQ:MDVN)

-28%

Pharmacyclics

(NASDAQ:PCYC)

-31%

FBIOX Top 10

Weighted Average

-16%

If FBIOX fund manager Rajiv Kaul allocates 54% of assets to the top 10, he must consider these the best of biotech. If the best of biotech suffered as much as the rest, then 1) the market has decided the industry as a whole is overvalued, and/or 2) investors are taking big profits; or 3) the sell off has been discriminate and regardless of valuations. The purpose of this article is to briefly discuss these possibilities.

High valuations on some biotechs has concerned me. Some commentators do not believe in applying conventional valuations to biotech stocks. I do, although I would be happy to be proven wrong. Certainly, P/E is meaningless, but I still use P/S ratio (market cap:revenue), and consider revenue important even if there are no sales. P/S provides only a snaphot valuation of a multi-faceted, dynamic company. But it is not easy to compare companies on dynamics like managment or the research and development being conducted on pipelines of new drugs. P/S should, however, provide a reasonable index of valuation inflation over a relatively short period of time for a given company.

To continue the line of thought, consider changes in P/S over the past 2 years for the 10 largest holdings in FBIOX. I have separated them, 6 in the 1st figure (BIIB, CELG, REGN, ALXN, AMGN, VRTX), then 2 others (MDVN, and GILD) in the 3rd figure; because ICPT P/S jumped so high to about 4,000 on January 9, 2014, I omitted the Ychart on that one. I also omitted P/S for PCYC because the Ychart is incomplete.

(click to enlarge)

The above Ychart hardly paints a picture of "bubble stocks." The average P/S for those 6 stocks was 11.3 in late March 2012 and is 11.7 as March 28, 2014. P/S at those dates for all of the FBIOX top 10 are listed here:

P/S 2012 Mar 27

P/S 2014 Mar 28

P/S % change

GILD

8.9

10.34

16%

AMGN

4.0

4.9

23%

BIIB

6.1

10.1

66%

CELG

7.5

9.2

23%

ALXN

22.8

19.3

-15%

VRTX

6.2

12.58

103%

REGN

23.6

15.5

-34%

MDVN

42.9

16.8

-61%

PCYC

23.0

29.4

28%

ICPT*

23.1

3529

15177%

*ICPT 2012 P/S as of October 11.

REGN and ALXN have the highest P/S in March 2014, but valuations have fallen despite superior revenue growth as charted below. AMGN still has the lowest P/S . CELG P/S expanded modestly from 7 to 9. BIIB P/S doubled from 6 to 11. P/S expanded the most for VRTX from 6 to 14. Among the six individual stocks, the 2-year change in the P/S multiple was actually inversely related to revenue growth which doesn't make much sense to me. The figure below shows revenue growth for these six.

(click to enlarge)

The figure below is for MDVN which was charted separately because it had the highest P/S of 43 in March 2012; P/S has fallen to 17 in 2014. GILD was also charted separately because in Ycharts it has a distorted P/S curve because of a 2:1 split. But GILD P/S has changed little: 9 to 10.

(click to enlarge)

Revenue has grown by an average of 56% since late March, 2012 for the six stocks shown in figure 2 above. Revenue also grew for the MDVN and GILD in the figure below:

(click to enlarge)

PCYC was not included in a Ychart. PCYC grew revenue more than 2,000% while its P/S expanded only 28%.

I do not understand the mind of the market. I do not know how efficient it is, a topic often discussed at SA. I am quite certain that valuations matter even in biotech, contrary to what some biotech investors say.

Valuations illustrated above indicate that most of the FBIOX top 10 are not over-valued in relation to revenue growth, and P/S ratios do not indicate that valuations have become inflated over the past two years as prices soared. Prices are being driven by revenue growth.

Some of the sell off is probably due to profit taking. PCYC, which enjoyed the greatest price apprecation in the industry over the past five years, has suffered the largest 1-month price drop among the FBIOX top 10.

However, the current sell-off is largely indiscriminate.

Recommendation:

If you have stock in a great company that is not overvalued (by that I mean triple- or quadruple-digit P/S), don't let the traders rock you out of the boat, only so they can buy back in at a lower price which they will likely do soon. If they don't, patient investors will begin to take notice of growth at a reasonable price in high quality biotech companies like those in the FBIOX top 10.

Source: The Biotech Sell Off Is Largely Indiscriminate And The Best Stocks Are Not Over-Valued

Additional disclosure: I do not have or plan to buy shares in FBIOX