Over the long run, the biotechnology sector has been a consistent winner in the stock market. The chart below shows the biggest winners among sectors over the past five years and biotech is near the top of the list.
This has often been the case for most of the past twenty years or so. As a group, biotechs have done well. There are always winners and losers within the group but the winners have usually done so well that the sector is consistently on the list of best performing sectors over the long run.
Recently, that has not been the case. The next chart shows the worst performing sectors over the past year. Because the stock market has delivered strong gains over the past year, most sectors show a gain. Just one shows a loss in this list. But biotechs have underperformed the market, a surprising turnaround based on their usual tendency to lead the market.
The under-performance is most likely due to politics rather than a fundamental change in the industry.
An example of a sector experiencing a fundamental change would be the energy sector. New technology has allowed more reserves to be recovered and the increase in supply appears to be permanent when compared to a few years ago. Higher supply usually leads to lower prices and that appears to be the case for oil and gas prices. This represents a fundamental change in the industry and companies are operating in a new environment based on those changes.
That does not seem to be the case for biotechs. As always, there are winners and losers in the sector. But there seem to be new concerns that politics may not allow the winners to be as successful as they were in the past. High drug prices are now a constant theme in the news media and there is a debate about what a fair price should be.
It may be the $1,000 pill that opened the door for the debate. There is a pill that cures hepatitis C and the list price on that medication is more than $1,000 a pill. A course of treatment can last 12 weeks making the cost of a cure more than $84,000. The debate is whether or not that cost is too high. The alternative to this treatment is lifelong treatment and could require a liver transplant costing more than $500,000. In the eyes of the patient, the pill is most likely worth the expense. In the eyes of the insurer, it probably represents a fair price since it avoids higher costs later on. Plus, the true cost of the pill varies by insurance company and is probably half or less of the sticker price.
The right price for life saving drugs is a complex question. But, politicians cannot debate in complex terms. They need to reduce an issue to a soundbite lasting just a few seconds or, in the past year or so, they might express thoughts on complex topics in tweets. In this environment, drug companies are at risk of being demonized and biotechs are suffering despite their promising earnings potential. This is most likely due to the fact that it is difficult to define the earnings potential when price cuts could be imposed by politicians who, at times, can usurp the role of the free market place.
Bad news, or the potential for bad news, usually leads to selling in Wall Street. The selling is often broadly based and rapid in a manner that can be described as “throwing out the baby with the bath water.” Traders become panicked rather than selective, selling the good along with the bad and, often creating bargains for the investor willing to dig a little into the numbers.
We dug through the biotech sector, looking for stocks that are trading at a low price and that are growing earnings. The combination of earnings growth and a low price could result in big gains for investors in these companies.
Neptune Technologies & Bioressources Inc. (Nasdaq: NEPT) is a nutrition products company that develops nutrition solutions and specialty ingredients. The company focused on the krill oil industry by conducting numerous clinical studies to establish the effectiveness of krill oil and its broad range of health benefits. Science is also central to the activities of Acasti Pharma, their pharmaceutical subsidiary. NEPT offers specialty ingredients such as premium krill oil, marine oils, and seed oils. The company sells its premium krill oil under the OCEANO3 brand directly to consumers through oceano3.com in Canada and the United States.
NEPT is expected to report earnings per share (EPS) of $0.02 this year and $0.10 next year. The stock is trading at about 10 times next year’s expected earnings and could easily double from its current level.
VIVUS, Inc. (Nasdaq: VVUS) is a biopharmaceutical company, developing and commercializing, next-generation therapies to address unmet medical needs in human health. The company offers Qsymia for the treatment of obesity as an adjunct to a reduced-calorie diet and increased physical activity for chronic weight management in adult patients with an initial body mass index of 30 or greater, or 27 or greater in the presence of at least one weight-related comorbidity, such as hypertension, type 2 diabetes mellitus or high cholesterol; and STENDRA, an oral phosphodiesterase type 5 inhibitor for the treatment of erectile dysfunction.
VVUS delivered a big earnings surprise last quarter, reporting EPS of $0.54, more than double analysts’ expectations of $0.23. Analysts expect a loss in each of the next two years but the loss is narrowing and that is generally considered to be an improvement in earnings.
PDL BioPharma, Inc. (Nasdaq: PDLI) acquires and manages companies, products, royalty agreements, and debt facilities in the biotech, pharmaceutical, and medical device industries in the United States, Europe, and internationally. The company website highlights that PDL BioPharma pioneered the humanization of monoclonal antibodies and, by so doing, enabled the discovery of a new generation of targeted treatments for cancer and immunologic diseases.
PDLI is expected to report EPS of $0.18 this year and $0.45 next year. The stock is trading at less than six times next year’s expected earnings.
Threshold Pharmaceuticals, Inc. (Nasdaq: THLD) is a clinical-stage biopharmaceutical company using our expertise in the tumor microenvironment to develop therapeutic agents that selectively target tumor cells for the treatment of individuals living with cancer. The company is currently developing two therapeutic product candidates: evofosfamide and TH-3424.
The company is narrowing its loss and trades at less than half the industry average price-to-book (P/B) ratio.
Protalix BioTherapeutics, Inc. (NYSE: PLX) is a biopharmaceutical company focused on the development, production and commercialization of recombinant therapeutic proteins produced by our proprietary ProCellEx® plant cell-based protein expression system. The company is the first to gain FDA approval for a plant cell culture expressed protein. Elelyso® (taliglucerase alfa for injection) is Protalix’s first drug product produced by its proprietary ProCellEx® protein expression system, and was approved for marketing by the FDA in May 2012, followed soon after by approval by ANVISA in Brazil, Israel’s Ministry of Health, and other regulatory authorities around the world.
PLX reported EPS of $0.61 last year but is expected to report a loss before earnings rebound again. The stock is relatively thinly traded and you should consider using limit orders to limit trading costs if you decide to buy PLX.
Based on history, any of these stocks could deliver a gain in the next year. We often see the losers from one year end up being the winners in the next year. Quantitative traders attribute this to the process known as mean reversion. We attribute it to the idea that value stocks often deliver gains and stocks that have sold off excessively are often undervalued.