While the average company in the biotechnology & drugs industry has shed about 2.6 percent of its value over the last three months, the AMEX Biotech index [BTK] is down about 7.8 percent. By comparison, companies comprising the AMEX Pharmaceutical index [DRG] are up about 1 percent, on average. Statistics and sample size help explain the discrepancy.
There are 543 companies in the Reuters biotechnology & drugs industry, but only 20 names in the AMEX Biotech index, many of which have come under pressure recently. Although shares for 14 of those companies have fallen more than 3 percent over the last three months, the index still looks relatively richly priced. The average price to earnings (P/E) ratio for companies in the index that reported positive results is about 85 - significantly higher than the average of 31 for the biotechnology & drugs industry. (Click here for an Excel sheet comparing the companies in the AMEX Biotech index.)
Looking for value opportunities in the biotechnology & drugs industry, we turned our attention to the 20 companies that recently appeared on at least one Reuters Select stock screen. (Click here for an Excel sheet comparing companies from the biotechnology & drugs industry that recently appeared on the Reuters Select stock screens.)
We then zeroed in on only those companies that appeared on a value screen. Only three companies came to light. Both Pharmaceutical Product Development, Inc. (PPDI) and United Therapeutics Corp. (UTHR) landed on the screen for Favored Value Plays. King Pharmaceuticals not only appeared on the Relative Value screen, but it also landed on screens in the growth and quality categories.
The Favored Value screen is designed to highlight companies that are not only trading at reasonable valuations but are also held in relatively high regard by the analysts who follow them. It incorporates an index ranging from 1.00 for a buy recommendation to a 5.00 for a sell recommendation, and it requires that a company must have an average rating less than 2.00. To avoid companies that are going through a downgrading cycle, the screen requires that the current rating must be less than or equal to its reading four weeks ago. The table below shows how Pharmaceutical Product Development and United Therapeutics both cleared this hurdle.
Although the average analyst rating for King Pharmaceuticals has improved, its average score of 3.18 is only slightly better than the 3.36 reading it had a month ago. This is relatively surprising when you consider that King also landed on the screen for Rising Expectations, which is designed to highlight companies where analysts have upped their earnings estimates in recent weeks. Over the last two months, the consensus earnings per share (EPS) estimate has climbed from $1.44 to $1.63 for this year and from $1.58 to $1.63 for 2008, accounting for its presence on the Rising Expectations screen.
The screen also requires that companies must have posted upside earnings surprises in each of the last four quarters. King also meets this criterion.
Of course, valuation is our key consideration here. A factor of both the Favored Value Plays screen and the Relative Value screen is the comparison of traditional valuation metrics to industry averages. Favored Value Plays requires that a company's P/E ratio must be less than the industry mean. It allows more wiggle room for the P/Sales ratio, which must be equal to or less than the industry norm. By comparison, the Relative Value screen filters for companies that have P/E, P/Sales and P/Cash Flow ratios that are no more than 10 percent above the industry average. As indicated in the table, below-average readings for select metrics helped these three companies satisfy the valuation requirements of these screens.
Disclosure: At the time of publication, Erik Dellith did not directly own shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.
Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.