There are very few stock market sectors that provide the consistent volatility and profit potential of the biotech industry. In fact, outside of derivatives, it can be safely said that biotech stocks are the number one fastest way to earn quick profits in the entire equity market.
The above graph from Forbes Magazine illustrates the extreme potential of the sector. The chart shows the distribution of returns for every biotech IPO since 2013. As you can see, a substantial percentage gained greater than 100% over the last two years. However, at the same time, a disturbing number plunged 25% or greater over this same time frame.
If you look at biotech performance since 2011 compared to the Nasdaq or the S&P 500, it truly outperforms the overall market.
Taking a look at the benchmark for biotech, the Nasdaq Biotechnology Index, it wrapped up 2014 higher by 34.1%. This crushed the primary market indexes that posted at 11.4% for the S&P 500 and 7.5% for the Dow Jones Industrial Average.
Despite the strong performance of the sector, not all biotech’s outperformed the stock market. Some were downright dogs and still others were wiped out during the same time frame.
The question is how to avoid the dogs and losers and only focus on the stocks most likely to succeed in this volatile sector.
Investors need to understand what makes a biotech deliver outperformance in the stock market.
While nothing is for certain in the stock market, the primary reason companies succeed in the space is due to strong clinical data. You see, early stage biotech’s all have the same goal, and that goal is to get drugs to the market. Strong clinical data is often a signal that FDA approval could be pending. It’s for certain that without substantial clinical data, the company’s product will not make it through the vigorous process of FDA approval. In addition, as firms make progress through the FDA approval procedure and hit various milestones, investors keep upping the ante on the shares, thus driving prices higher.
While pushing succesful drugs through the hurdles of FDA approval and the company’s own internal pipeline is a primary catalyst for stock price reactions, there is a catalyst that provides even faster share price reactions.
This catalyst is when the biotech company goes “in play”.
This means merger and acquisition activity. Whenever a larger company starts to show interest in acquiring or merging with a smaller company, it’s close to guaranteed that share prices will climb higher. Just the rumor of a potential takeover can send share prices soaring.
Rather than provide examples of the countless times biotech’s have taken off higher on the rumor and news of a potential takeover, it is much more valuable talk about biotechs that are currently in play.
The great news is that the very recent gigantic takeout of Synageva by Alexion Pharmaceuticals. This deal is valued at $8.4 billion and this action has focused investor’s attention on potential future activity in the biotech space.
Right now, analysts are focused on Vertex Pharmaceuticals (Nasdaq:VRTX) as the biotech most likely to be a takeover candidate.
Vertex has been on fire lately with a 31% increase in product revenue for its leading product, Kalydeco, first quarter 2015 over same quarter last year. Kalydeco is a drug targeting the crippling malady of cystic fibrosis. This drug is part of a group of cystic fibrosis drugs from Vertex. These drugs would make an ideal product category for the giant Gilead (Nasdaq:GILD).
Geoff Porges, Bernsteins biotech analyst, stated succinctly, "With a 50 percent premium over Vertex’s recent stock price, a $45 billion cash and debt deal would be 7-8 percent dilutive to [Gilead] in 2015, but would be accretive after 2017, assuming 27 percent cost savings."
The most exciting thing is that, should this takeover occur, it will be a win/win for both company’s investors. Gilead is projected to soar 30 to 40 percent due to Porge’s reasoning.
Adding to the hype, Gilead’s CEO, John Martin, mentioned his firm’s willingness to acquire a company or two during the latest earnings call. Martin stated"I can’t tell you that we have an appetite for things large or small; it has to be kind of the right fit for Gilead." He added, So,we are open to suggestion; there have been many mentioned out there."
Rare disease company BioMarin Pharmaceuticals (Nasdaq:BMRN) also has serious odds of soon being a takeover play. We first brought this company to your attention as a winning stock in our Consensus Picks premium newsletter.
Several months ago, we pointed out that this orphan drug maker is up over 35% in the last 52 weeks. Considered a midcap drug maker, the company recently had its target price increased by 6% to $123.00 per share by Nomura Securities.
Biomarin boasts five marketable, approved products and multiple others in the pipeline. Unlike an unproven biotech, this company posted over $500 million in sales. A recent acquisition of Prosensa Holdings adds to the company`s stable of profitable products.
These products are what provide BioMarin its $18 billion market cap. Deutsche Bank has recently reported that takeout valuation for the company could be as high as $217.00 per share. That represents close to a 100% increase from the present trading price of $121.50 per share. We called a target of $135.00 per share prior to the takeover rumors so obviously, share prices could go much, much higher.
Names of Sanofi and Shire have been thrown into the ring as possible acquirers.
Aggressive corporate action has placed cancer drug maker, Ariad Pharmaceuticals (Nasdaq:ARIA) on the possible takeout list. In April, CEO Harvey Berger was removed from his position by board member and activist investor Alex Denner from Sarissa Capital.
This activity triggered speculation that additional aggressive activity may be just around the corner. Ariad boasts a solid pipeline of cancer drugs making it very appealing to larger firms seeking to add to its stable of cancer medications. This activity has already sent shares higher by 33% this year alone which lifts its market cap to $1.7 billion.
How to Play These Takeout Candidates
The smartest way to play these takeover candidates is to set your buy order above the current trading price and simply wait for an explosive upward move to carry the trade into profits. Let’s look closer at each of the names.
- Vertex Pharmaceuticals
Set the buy order to execute on a break of the $130.00 level. Set initial stops at $124.93 per share to account for the inherent volatility.
- BioMarin Pharmaceuticals
Wait for this one to break above $125.00 per share to enter longs. Initial stops set at $118.33 per share makes sense on this potential rocket stock.
- ARIAD Pharmaceuticals (Nasdaq:ARIA)
Enter this stock on a break of the $9.75 per share high. Initial stops are suggested at $8.33 per share.
Remember to trail the stops higher as price moves up. Price moves are often very aggressive in both direction, so take your profits when you are able!