Investors' 3 Most Loved Biotech Stocks

As I said yesterday, the biotech sector can be like a roulette wheel at times. When you choose correctly, it can turn into a double, triple, or even 10-bagger; and when you miss, you could very well lose 80%, 90%, or practically all of your investment depending on the depth of a company's pipeline and the amount of cash it has on hand to cover its expenses.

The reason I bring this is up is because yesterday we took a closer look at the markets most hated biotech stocks. The reason behind the deeper dive was to see if emotions were getting the better of investors and to decipher if common traits appeared between those three biotech stocks that we could use to avoid running into a heavy dose of short sellers in the future.

Source: Wendy, Flickr.

Today, we're turning the tables. Instead of focusing on the markets' most hated biotech stocks, we'll look at the least short-sold biotechs and see what, if anything, these three companies share that tends to keep the pessimists at bay. Remember, a small number of short shares could be an indication that a stock could head higher, so it's worth using these most loved biotechs as a learning tool.

As one final note, I've excluded biotechs trading below a market cap of $200 million and with a share price below $1 because many can't be sold short, which would give us a falsely low short ratio.

China Biologic Products (NASDAQ: CBPO  ) : 0.06% of float shares sold short
If you're scratching your head because you've never heard of China Biologic Products, don't worry, you aren't alone. I pride myself on keeping track of as many companies in the health-care sector as possible, but this integrated plasma-based Chinese biopharmaceutical company isn't one that's wound up on my radar before.

The first factor I notice that would certainly keep short sellers at bay is the average daily volume for China Biologic Products, which is an anemic 14,400 shares per day. Low volume stocks are typically bad news for short sellers who are generally looking for a quick trade and usually prefer high liquidity in the stocks they bet against. Another way of looking at this is that the current shareholders in China Biologics seem content to just hang onto their shares, which is great news for the long-term investor.

Another aspect that will clearly keep short sellers at bay is top- and bottom-line consistency. In the second quarter, China Biologic delivered 6.2% sales growth on its plasma-based products as it was able to boost pricing while keeping costs flat year over year. The end result was beefier margins than in the year-ago period, which is bound to keep investors happy.

If you're looking for a reason to be worried, the only thing I can come up with is the company's location: China. Although we're a good two years past the more than one dozen Chinese small-cap companies that turned out to be cooking their books, it nonetheless still sits fresh in the minds of investors in the U.S. In fact, many very low-volume China-based micro caps have been rallying despite no news in recent months, lending credence that another bubble could be brewing.

In sum, short sellers are probably right to stay away based on liquidity concerns, but I wouldn't be surprised to see pessimism build given the odd spike in many Chinese issues lately.

Biogen Idec (NASDAQ: BIIB  ) : 0.92% of float shares sold short
Now here's a company that I fully understand why short sellers have kept their distance from.

Biogen Idec has a diverse pipeline of existing and experimental products, but what you need to understand about this company is that it's a juggernaut when it comes to treating multiple sclerosis. Biogen reported its third-quarter results just yesterday and delivered 32% revenue growth to $1.8 billion as earnings per share jumped 23% to an adjusted $2.35. That's certainly not chump change for a $60 billion company.

The big growth driver here is newly approved oral relapsed MS drug Tecfidera, which brought in $286 million for the quarter, a 48% sequential quarterly increase, and is now the leading MS relapsing drug in the U.S. according to IMS. Tecfidera is also on pace to become a blockbuster drug (i.e., sales surpassing $1 billion) within its first 12 months on the market.

The fact that Biogen is also now receiving 100% of Tysabri's revenue stemming from its $3.25 billion purchase of its global rights from Elan (UNKNOWN: ELN.DL2  ) earlier this year is another key factor for why its sales jumped so dramatically. Tysabri revenue jumped 46% to $401 million in the quarter and should continue to be a consistent source of near-term growth for Biogen.

There's also the point that Biogen doesn't have any patent expirations to worry about for at least a couple of years and Tecfidera sales are likely to soar for at least the next couple of quarters.

Even with the huge run Biogen's had this year, it's still valued at just 23 times forward earnings, a reasonable figure considering that it could grow sales by about 20% in each of the next three years. That's probably not anything that short sellers want any part of.

QLT (NASDAQ: QLTI  ) : 0.99% of float shares sold short
QLT's extremely low short ratio compared to the previous two companies is certainly the most confusing of all.

QLT has been in major divestment mode over the past year, selling off its Visudyne operations to Valeant Pharmaceuticals (NYSE: VRX  ) in September 2012 for $112.5 million and selling its punctal plug delivery system technology in April of this year to Mati Therapeutics for $1.25 million as well as the potential to earn $19.5 million in milestone payments. QLT will also receive single-digit royalties on all drugs developed by Mati utilizing its PPDS technology.

These deals helped boost QLT's cash balance up more than $300 million, which it then used to issue a special dividend of $200 million ($3.915 per share) at the end of June. The run-up into that huge cash disbursement could be one factor that's kept short sellers at bay. In addition, even with that humongous cash disbursement, QLT still boasts $103.2 million in cash, which represents 45% of its current market value.

Ultimately, though, what makes QLT an intriguing but at the same time dangerous play is the fact that it's once again a clinical-stage biotech company. It has just one drug in early-stage development in its synthetic retinoid program (QLT091001), but for two different indications, Leber Congenital Amaurosis and retinitis pigementosa. Clearly, we've seen a lot of success with ocular therapies in recent years (ahem, Regeneron Pharmaceuticals with Eylea), but there's no guarantee of success here with such an early-stage pipeline focused on one compound.

Although we've been given no indications to be concerned from the study data, I wouldn't be surprised to see QLT's short interest rise with pretty much just a cash buffer and one drug supporting its current valuation.

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