Is the Biotech Bubble About to Burst?

"Bubble" can be a provocative word in investing circles. Think of all that comes to mind when you hear it -- perhaps other words like over-hyped, overvalued, risky, etc. To quote from our own Motley Fool investing wiki, a bubble "occurs when people are happily paying more for stocks in a certain sector than they are worth given the fundamentals of the businesses." That happy buying keeps on going and going until it stops. Then the bubble bursts.

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Many investors are definitely paying increasingly more for biotech stocks. I suspect that they're happily doing so. Major exchange-traded funds, or ETFs, that track biotech stocks are up over 30% so far this year -- easily beating the broader indexes, which have done quite well themselves. But is biotech actually in a bubble right now? If so, is that bubble about to burst? It depends.

Yes and no
Not all of these biotech run-ups have necessarily valued stocks more than the business fundamentals warrant. For example, shares of Celgene (NASDAQ: CELG  ) have soared by more than 70% in 2013. But if you look at the company's likelihood of continuing to grow earnings with sustained strength from Revlimid and great potential for other drugs like Abraxane and Pomalyst, Celgene's price doesn't seem too high even after an enormous run.

On the other hand, it isn't too difficult to find examples of biotech stocks that seem to have flown well past what their current fundamentals justify. There are some small companies with little to no revenue and no product likely to hit the market in the next couple of years that have skyrocketed to premium valuations.

For example, shares of Cytokinetics (NASDAQ: CYTK  ) have jumped more than 180% year-to-date. The small biotech currently claims a market cap of around $325 million. That's nearly 60 times the $5.7 million in revenue that Cytokinetics has made over the last 12 months -- and it's not likely to see significantly more revenue in the immediate future.

The biotech has no products in phase 3 development yet, although it is in collaboration with Amgen (NASDAQ: AMGN  ) on a heart muscle drug that is in two different phase 2b studies and has another neuromuscular drug in phase 2b. Amgen holds a $10 million stake in the company as part of the licensing deal.

There also are biotechs that have had a great ride in 2013 but could see more challenging days ahead. Astex Pharmaceuticals (NASDAQ: ASTX  ) stock has more than doubled so far this year. It has a market cap of around $550 million on nearly $80 million in sales over the last 12 months. However, Astex expects that sales for its lead product, Dacogen, will drop next year in the U.S. with the entrance of generic competition. 

Stocks like Cytokinetics and Astex would likely fall heavily if the presumed biotech bubble burst. Of course, when bubbles burst they tend to take most of the stocks in the sector down.

The bubble that wasn't
Back to the original headline question, though: Is the biotech bubble about to burst? My view is that it won't -- because it's not really a bubble after all.

I looked at the top 10 holdings of the iShares Nasdaq Biotechnology ETF. These 10 stocks comprise more than 55% of the total assets held by the ETF. If we were seeing a bubble in biotech stocks, how many of these would you think would be at historically high price-to-earnings multiples? Maybe eight or nine of them? At least half?

The actual answer is that only two of the top 10 biotech stocks in the ETF are at their five-year highs for valuation -- Biogen Idec and Gilead Sciences (NASDAQ: GILD  ) . I would argue that, like Celgene, neither of these stocks are too highly priced considering their earnings potential. Gilead, especially, looks strong in my view with its solid HIV franchise and big opportunities ahead stemming from its frontrunner status in commercializing an all-oral hepatitis C virus drug.

Sure, some biotech stocks are overvalued. I don't think the sector as a whole is, though. Biotech could become "bubblicious" at some point. For now, though, I suspect we'll see more stocks continue to pop than have their bubbles burst.

Staying out of biotech stocks out of fear that a supposed bubble will burst probably isn't a good idea. Consider that millions of Americans have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest and put their money at further risk. Yet those who've stayed out of the market have missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.


Read/Post Comments (4) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 27, 2013, at 2:55 PM, PharmTeam wrote:

    The fact that investors don't know when CYTK will receive revenue in the form of milestone payments is worrisome, and it's really important to keep an eye on their cash burn. But, with that being said, they have a steady $75million in cash/securities, no debt, and AMGN is funding all of Omecamtiv Mecarbil's trials. Fundamentals are iffy, but the market value represents enthusiasm in the science.

  • Report this Comment On August 29, 2013, at 11:08 AM, mgw6 wrote:

    Some of the larger biotech companies look and act more like Big Pharmas (e.g., Amgen, Gilead, and Biogen-Idec). The diversity of companies makes it difficult to characterize a "bubble" if it might exist, especially when it comes to defining a market. The overwhelming majority of what might be considered "pure biotech companies" are still small early stage companies working on biologics. See "The Five Types of Biotechnology Companies" at PharmaReform.com

  • Report this Comment On September 04, 2013, at 9:06 PM, 007mercucio wrote:

    I think it is ridiculous to say biotech is a bubble about to burst. Regenerative medicine is at a pivotal stage, relative to all past medicine... in the entire history of mankind. The newness of it all means that investors have a chance to get in on the floor of something which could mushroom to an unfathomable scale. Investors would be foolish not to look at the potential rewards of biotech. The market cap of biotechs goes up as their likelihood of marketable products does, that, times the potential profit... the era itself explains the increases... the tech itself is growing, and therefore the investability into the tech.

  • Report this Comment On September 10, 2013, at 3:33 PM, harry2013 wrote:

    When I look at companies like Clovis Oncology with only Phase I candidates valued at $2 billion, and Aegerion worth $3 billion based off a drug that's 2014 revenues are estimated to be $180MM, and peak at $250-300MM, for a drug that assumes pricing of $300,000/year, and dozens like these, it's hard not to think it's a bubble. I don't think the realities of time needed to conduct clinical trials and failure rates have changed that much in the last 10 years. I do sense an easier FDA, though. For people who have been looking at this space for a long time, an open biotech window is more or less a good indicator the the investing world is willing to take a lot of risk, in general. When that ends, it will be back to business as usual (huge slump, followed by another up-cycle a few years later).

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