Spectrum Pharmaceuticals Reached 10-Year Highs But Has At Least 20% Upside In The Immediate Future

When the market closed on Monday July 2 Spectrum Pharmaceuticals (NASDAQ:SPPI) was trading at 10-year highs, which means that anyone who bought shares in the last 10 years is now holding their position with a gain. Personally, Spectrum closing at 52-week highs meant that SPPI is now the largest holding in my portfolio, crossing XPO Logistics by a whopping $12! However, my portfolio is irrelevant, but what is important to investors is what happens next. Will the stock trade higher? Or will it now reverse and trade lower?

I often compare SPPI with another holding in my portfolio, Questcor Pharmaceuticals (QCOR). Both are great companies, have excellent upside potential, and are fundamentally similar. However, the two companies operate with different strategies, Questcor is driven by one drug with billion dollar potential and SPPI is driven by a multitude of drugs and a large pipeline through acquisitions.

Over the last month QCOR has traded with a very large aggressive rally, creating new highs on a daily basis (until this last week). On June 11 QCOR reached new highs, similar to SPPI on Monday, it then continued to trade higher over the following two weeks by nearly 20%. This matches a trend in biotechnology that has occurred over the last few weeks, in which other stocks such as Pharmacyclics (NASDAQ:PCYC), Incyte (NASDAQ:INCY), and Alexion Pharmaceuticals (NASDAQ:ALXN) all reached new highs and then continued to trade even higher. I am now looking for a second round of stocks to follow the same trend, such as SPPI and Amarin Corporation (NASDAQ:AMRN).

There is one difference in particular that makes SPPI so intriguing as an investment, compared to all other biotechs that have rallied over the last month, and that is its valuation. Spectrum's valuation is non-comparable to any other biotechnology stock in the market. Even at 52 week highs the stock is trading with a P/E ratio of just 12.23, which suggests that the company is either growing slowly, or possibly even losing revenue on a quarter-to-quarter basis. However, take a look at how SPPI measures against QCOR, which are two of the fastest growing companies in biotechnology, over the last 12 months compared to 2010.

Revenue (millions) $115.13 $74.11
Net Income (millions) $35.07 ($48.84)
Click to enlarge

As you can see from the above chart QCOR was the larger, and better, company in 2010. QCOR was profitable, with more than 55% of higher revenue compared to SPPI, and nearly $85 million more income. Therefore, with these two fundamental measures alone it would make sense that QCOR would be valued significantly higher than SPPI. With that being said, let's look at the last 12 months and see how the two compare. Keep in mind that QCOR had 55% more revenue and the difference between the two companies income in 2010, just one year prior.

Last 12 Months
Revenue $277.30 $209.22
Net Income $106.91 $82.28
Click to enlarge

The first thing that we should note is that both companies are growing at a remarkable rate, with no end in sight. However, in 2010 QCOR posted 55% more revenue than SPPI; but during the last 12 months QCOR has only 32% more in sales than SPPI. This shows that SPPI is growing much faster than QCOR, seeing as how it closed the gap so quickly. In fact, QCOR has posted revenue growth of 140% compared to 2010, while SPPI improved sales by 180%. And since SPPI posted a net loss in 2010 it is hard to draw an income comparison, however I think the fact that the profit margin of both companies are near exact speaks to the efficiency of SPPI's strategic plan.

Warren Buffett often talks about his process when buying stock, or acquiring, a company. He is known to read the annual report of a company without knowing its market cap, or its market worth, and then he determines how much he believes the company is worth based on its fundamentals. Therefore, when you look at the fundamentals and growth of both QCOR and SPPI what would you say both companies are worth? Keep in mind that you must account for the fact that SPPI is growing faster, which should mean a larger P/E and price/sales ratio.

When I look at the fundamental growth of both companies I determine that SPPI and QCOR are virtually worth the same in terms of market capitalization. QCOR is slightly larger, but SPPI is growing faster, therefore it may be fair to suggest that QCOR is worth $500 million more than SPPI seeing as how it is 30% larger in terms of fundamentals. However, as you know, QCOR trades with a market cap of $3.26 billion (I believe fairly valued) and SPPI has a market cap of $950 million, meaning that QCOR is valued by more than 3x SPPI, according to investors. Yet QCOR's revenue and income are only greater by 30% compared to SPPI over the last 12 months.

Now let's jump back to the original topic, which is what happens next for SPPI in terms of performance. I believe the stock is undervalued by an unprecedented level, and that because of optimism within the biotechnology space that it will continue the trend of previous biotechnology stocks that are creating new highs, with an immediate 20% upside from its current price, therefore placing a target of $19.20. However, I believe the stock could easily surpass $20 and represent the largest rally following a new high that we have seen in 2012. Because if I were looking at just the fundamentals without knowing its market cap I would value SPPI with a P/E ratio of at minimum 25 due to its explosive growth, therefore representing a low price of $33.00 per share. And although it is unlikely that SPPI will double in the next month it does make sense that a massive rally is very possible, and that all the pieces are in place for such a rally to occur. Because SPPI is simply presenting a value that is unmatched anywhere in the entire stock market, which means any rally could be huge.

Disclosure: I am long SPPI, QCOR.

Additional disclosure: The topic discussed in this article is for informational purposes only and should not be used for making any investment decisions.