* Note to reader: All data are as of the close of Monday, October 6, 2014, and are still relevant for the purpose of the comparison, producing precisely the same results.
Having lagged behind the broader market S&P 500 for the first half of the recovery since the 2008-09 financial crisis, the biotechnology industry has been absolutely on fire in the second half, beginning after the mid-2011 correction. And with good reason: ultra-low interest rates.
Researching and testing new drugs is extremely capital intensive, with biotechs having to borrow heavily before successfully bringing a new drug to market. Interest rates at multi-decade lows, therefore, have helped biotechs enormously as they can not only borrow new funds at low rates but can also refinance older debts at cheaper rates too, reducing their liabilities and bringing their cost of doing business down considerably.
Moreover, when new drugs win FDA approval, are licensed to major pharmaceutical companies and are successfully marketed into blockbusters, the biotechs that invented them enjoy a windfall in stock price appreciation, giving the biotech industry explosive bangs for their investors' bucks.
As a result of this access to ultra-low financing and explosive upward surges on the approval and release of new drugs, the biotech industry has simply screamed past both the healthcare sector and the overall broader market as depicted in the graph below, with the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB) [blue] soaring 225% since the mid-2011 correction, while the SPDR healthcare sector ETF (NYSE: XLV) [orange] has climbed just 115% and the S&P 500 [black] has managed only 75%.
Zooming into the biotech industry, our two highlighted biotechs of Gilead Sciences (NASDAQ: GILD) [beige] and Amgen (NASDAQ: AMGN) [purple] have beaten both the broader market S&P and healthcare's XLV, yet at wildly differing rates as Gilead has nearly tripled Amgen's surge.
As fun as the ride for the biotechs has been over the past three years, the future for the industry looks better still, as noted in the table below comparing the earnings growth for the Biotechnology industry to its Healthcare sector and to the broader market S&P 500. Green indicates outperformance while yellow indicates underperformance as compared to the S&P.
As noted above, the earnings per share growth of both the Biotechnology industry and its Healthcare sector are expected to outperform the S&P average overwhelmingly in 2014 and 2015, while continuing to solidly outperform over the next five years.
Within the Biotechnology industry, however, our two highlighted stocks are expected to register another split performance reminiscent of the last three years, as noted in the table below, with Gilead's earnings per share growth expected to surpass the biotech industry's, while Amgen's is seen lagging.
Even so, both Gilead and Amgen should prove solid holdings that offer exceptional growth prospects going forward. But how do the two compare against each other, and which makes the better investment?
To answer that, let's have a look at their company fundamentals using following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recent quarter, Gilead enjoyed superior revenue and earnings growth year-over-year by a substantial margin.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of the two, Gilead's profit and operating margins outperform Amgen's by a considerable margin here too.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
In both returns on assets and on equity, Gilead's management team once again outmanoeuvres Amgen's team by quite a large margin.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
In this metric, Amgen finally scores a win against Gilead by providing common stock holders with the greater diluted earnings per share gain as a percentage of its current share price, though not by much.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Between our two combatants, Gilead has the cheaper stock price relative to forward earnings and a more attractive PEG ratio, while Amgen has the better price to book value.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our two specimens, Gilead yet again outperforms Amgen, this time in earnings per share as a percentage of current stock price, pulling further ahead over time.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For overall earnings growth, you guessed it, Gilead is expected to post better earnings growth than Amgen in all time periods, and by a substantial margin straight across the board.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean, and low price targets over the coming 12 months, analysts seem to really like Gilead a great deal, projecting superior stock price gains over Amgen. Yet they consider Gilead's stock to contain more downside risk, likely due to its steeply inclining trajectory as of late.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our two contenders, Gilead is, not surprisingly, better recommended with 10 strong buys and 13 buys representing 38.46% ad 50.00% of analysts surveyed, while Amgen garners 3 strong buy and 9 buy ratings.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Gilead, a forgone conclusion I'm sure, outperforming Amgen in 23 metrics and underperforming in just 7 for a net score of +16, while Amgen scores the reciprocal, outperforming in 7 metrics and underperforming in 23 for a net score of -16.
While the whole of the Biotechnology industry is expected to outperform the broader S&P by a substantial amount in 2014 and beyond, the two largest U.S. companies in the space seem to be poised to continue straddling the line, with Gilead solidly planted above and Amgen slightly below their industry average. Yet both should prove valuable holdings in any portfolio looking to capitalize on the Biotech industry's robust future prospects over the broader market.