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Can Investors Gain from the New Age in Medical Testing?

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We might be entering a new age in medical testing. Molecular-level diagnostics, or tests based on the role genes play in human diseases, looks to provide earlier detection and more effective treatments for the most deadly conditions. Can investors profit from this diagnostic testing revolution via sector participants such as Illumina (NASDAQ: ILMN  ) , Myriad Genetics (NASDAQ: MYGN  ) , or Bio-Rad Laboratories (NYSE: BIO  ) ? Let's take a look.

A leading company at an enthusiastic price
Illumina is a leader in the field of genetic analysis. Providing tools that scientists use to breakdown and analyze genes, the company sells to medical research centers, biotechs, and pharmaceutical companies.

The more medical research delves deeper into the mystery of the gene, the more Illumina gains. In its recently completed fiscal year, revenues jumped 24% and adjusted net income climbed 19% from the prior period. For the current year, the company is projecting an additional 15% to 17% rise in revenues with adjusted earnings per share growth of over 10%.

New products will also help boost demand. The company's recently introduced HiSeq X Ten Sequencing System could be a big seller. The HiSeq X Ten delivers massive amounts of gene information quicker and at a significantly lower price, about 10% of past cost. Eric Lander, founding director of the Broad Institute and a professor of biology at MIT, believes that "over the next few years, we have an opportunity to learn as much about the genetics of human disease as we have learned in the history of medicine." This achievement is due to products like Illumina's HiSeq X Ten. 

While Illumina appears to have tremendous prospects, investors may have already factored much of the good news into the stock. Currently trading at over 60 times forward earnings, basically net income plus non-cash charges such as depreciation and amortization adjusted for expected capital expenditures, the company's shares may be priced too enthusiastically and could be vulnerable to any kind of disappointment.

Investor optimism despite recent troubles
Bio-Rad Laboratories is a long-time, well-entrenched participant in the medical diagnostics sector. While not embedded in technologically advanced markets like Illumina, Bio-Rad does have a leading position in its core lab products and systems markets.

The company has been facing some recent headwinds, however. Top-line growth has been sluggish with profits under pressure. Bio-Rad's latest quarterly revenues increased a slight 1.3% year-over-year and net income fell to a loss of $7 million compared to income of $42.6 million a year earlier. Higher employee costs from a series of acquisitions and expenses associated with a major computer system upgrade were the main reasons for the profit falloff. 

Bio-Rad has also encountered some administrative troubles. Currently being investigated for violations of the Foreign Corrupt Practices Act, the company is in settlement talks, but the timing and ultimate price of a resolution is still unknown. Bio-Rad additionally announced the identification of some accounting errors dating back to 2008. While the figures involved don't appear material, the news was disquieting.

In a sign of investor enthusiasm for diagnostic testing product companies as a whole, Bio-Rad's weak sales growth and administrative turmoil have surprisingly not distressed its shares. Priced at over 20 times forward earnings, it appears the stock market has already anticipated improved performance.

Caution trumping current growth
Myriad Genetics might be the most interestingly positioned diagnostic testing company. A leader in providing individual patient tests that assess the risk of developing a disease based on gene profile, demand for the company's products has soared.

In its most recent quarter, revenues increased an impressive 52% year over year and earnings per share jumped a whopping 89%. Requests for Myriad's BRACAnalysis test, a genetic review that confirms the presence of gene mutations responsible for the majority of breast and ovarian cancers, produced about 74% of all sales. 

The company's strong performance has been overshadowed by a couple of major setbacks, however. A recent U.S. government proposal to cut BRACAnalysis reimbursements stunned investors. Though government payments make up only about 10% of BRAC testing sales, the reduction suggests health insurance payers might also look to reduce fees. Additional pricing pressures will be applied thanks to last summer's adverse U.S. Supreme Court decision that invalidated some of Myriad 's gene patents. Myriad will likely now face determined and aggressive competition in the patient genetic testing market.

In spite of the reversals, the company looks ready to deliver a multitude of new tests. Myriad recently launched a product that detects a possible gene indicator for increased colon cancer risk. Another test introduction relates to a highly significant predictor for patients with early stage lung cancer. Promising gene-based analytic procedures for breast, prostate, and melanoma cancers are also being developed. 

Can the growth in genetic testing generally and Myriad's onslaught of new procedures outpace potential pricing pressures? Investors appear skeptical. Currently valued at only around 16 times forward earnings, the company seems priced at a noticeably cautious discount to other industry participants. The company could potentially offer some share price upside if results aren't as dire as expected, however.

We may be on the cusp of a new age in medical testing. Increased capabilities in gene analysis could initiate previously inconceivable advancements in drug discovery and patient health. How can investors benefit? While the sector's future is certainly bright, excessive enthusiasm may have pushed share prices dangerously high. Patiently waiting for opportunistic price pullbacks in well regarded stocks like Illumina and Bio-Rad Laboratories or holding out for reimbursement rate stability at besieged Myriad Genetics may be the surest way investors can profit from this momentous testing revolution.

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Bob Chandler

A dedicated Graham-style value man, Bob bought his first stock in 1986 and though he’s a miserable market timer, longer-term calls let him earn a meager living from his investments. With an MBA and MS in Accounting, Bob relies more on Hetty Green's advice for successful investing: "Buy cheap and sell dear. Act with thrift and shrewdness and be persistent."

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