1 Big Reason to Doubt the Biotech Bubble Chorus

Raise your hand if you've heard the words "biotech" and "bubble" used in the same sentence recently. Observers from virtually every corner have joined the chorus singing the blues about the biotech sector. Some might even be humming a funeral dirge.

After all, biotech stocks have taken a beating over the last week. Shares of Biogen Idec (NASDAQ: BIIB  ) dropped 10%. Alexion Pharmaceuticals' (NASDAQ: ALXN  ) shares plunged 16%. Others didn't suffer as badly, but few have seen any significant gains over the past several days.

With so many proclaiming that biotech stocks are in a bubble and that bubble is popping before our eyes, why not join the refrain? There's at least one significant reason for doubt that a biotech bubble is in progress. That reason can be summed up in one word: growth.

Source: Wikimedia Commons 

Expensive bargains?
It's easy to look at the iShares Nasdaq Biotechnology ETF's (NASDAQ: IBB  ) price-to-earnings multiple of 29 compared to the S&P 500's P/E of 16 and think that biotech is expensive. If the rearview mirror was the only thing that mattered to the market, that verdict would probably be correct. But the market is much more focused on what's ahead than what's in the past.

Future prospects for at least two of the biggest stocks in the iShares biotech ETF appear to justify their lofty valuations and leave plenty of room to run even more. Gilead Sciences (NASDAQ: GILD  ) and Celgene (NASDAQ: CELG  ) together make up almost one-seventh of the fund's total assets. And both look like relative bargains in terms of growth potential despite racking up huge gains over the last year.

Sovaldi has been the big story for Gilead. The hepatitis C drug stands to be one of the most successful drugs on the market. Many eagerly await Gilead's next act, a combination of Sovaldi and another of its products, GS-5816, which will be basically the holy grail of hepatitis C -- one oral pill that effectively cures the viral disease.  

Largely because of the promise of the Sovaldi franchise, Gilead's P/E-to-growth, or PEG, ratio comes in at a stunningly low 0.52. Legendary investor Peter Lynch's rule of thumb was that a fairly valued company would have a PEG of 1. Using Lynch's premise, and assuming a bundle of other things go right, Gilead could roughly double its share price from current levels to be fairly valued.

Celgene, meanwhile, continues to add to its arsenal. Just a few days ago, the biotech gained U.S. approval for Otezla in treating psoriatic arthritis. Celgene already claims megablockbuster Revlimid and near-blockbuster drugs with Abraxane and Vidaza, along with up-and-comer Pomalyst.

Sustained strength from Revlimid combined with solid performance from Celgene's other drugs led the company to project earnings-per-share growth of 19% this year. The biotech's PEG ratio of 0.81 indicates that the stock still may have potential to move higher. 

Bubbling?
The biotech bubble chorus would sing that PEG numbers can be horribly wrong since they're based on estimates. And their song would ring true. Growth projections can sometimes be way too optimistic.

Some might point to risks for Gilead, in particular, after several congressmen requested the company explain why Sovaldi costs so much. Some payers are pushing back against the drug's price tag of $84,000 per 12-week treatment course. Concerns have risen that a significant backlash could mean Gilead's profits will climb more slowly than initially thought.

It's also important to note that not all biotech stocks appear to be as attractively valued when growth prospects are factored in. Biogen, for example, boasts a terrific drug powering its growth with Tecfidera. However, the company's PEG currently stands at nearly 1.7 -- well above Peter Lynch's fair value benchmark.

Alexion, likewise, continues to experience strong increased sales from Soliris, which treats the rare diseases paroxysmal nocturnal hemoglobinuria and atypical hemolytic uremic syndrome. That growth seems to be perhaps largely baked into the stock, though. Alexion has a PEG ratio of 1.18.

Singing a different tune
My view is that the real answer to whether we're seeing a biotech bubble is more nuanced. I suspect some stocks in the sector that have enjoyed a great ride for a long time could continue to be knocked off their perches. On the other hand, several biotech stocks still look like solid picks for the foreseeable future.

I would definitely include both Celgene and Gilead Sciences in the latter group. I'm looking forward to Gilead's response to the congressional inquiry, which will no doubt point out that patients who take Sovaldi are much less likely to require a liver transplant, which costs in the neighborhood of $600,000.

As a whole, the biotech sector still looks attractive factoring in growth potential. Geoff Meacham at JP Morgan notes that the PEG ratio for biotech is around 0.7 -- around half the value of the S&P 500.

Let the biotech bubble chorus keep singing -- and making stocks like Celgene, Gilead, and others which may have great days ahead of them more inexpensive to buy. That should be music to Foolish investors' ears.

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  • Report this Comment On March 27, 2014, at 8:02 PM, jerryguru69 wrote:

    actually, I found a better biotech ETF.

    IBB has an expense ratio of 0.48% and dividend of 0.001%.

    XBI is 0.35%, and yield is 0.30%, so the dividend almost pays for the fee.

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