Are Biotechs Overvalued?

Is the Fed right when it says biotechnology stocks are overvalued?

Jul 21, 2014 at 10:15AM

U.S stocks are marginally lower on Monday morning, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES:^DJI) down 0.38% and 0.48%, respectively, at 10:18 a.m. EDT. This week is relatively light in terms of economics data, but earnings season rolls on. Today's most anticipated results are those of streaming video and television service Netflix, which reports after the market close. There has been much debate concerning whether Netflix is overvalued, but the Federal Reserve expressed more concern about overvaluation in the social media and biotechnology sectors in its biannual monetary report last week. That warning appears to have taken its toll on the latter sector, with the Financial Times reporting on Sunday that investors have pulled $445 million from the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB) so far this month, or roughly 9% of the fund's net assets. That means the fund has now suffered a net outflow year to date to the tune of $77 million, compared to a net inflow of $747 million in 2013.


There were two "offending" passages in the Fed's report. The following is the more broad characterization (my emphasis):

Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms.

The Fed believes the worst excesses are at the intersection of these two groups, where valuations appear "substantially stretched" versus plain "stretched" (my emphasis):

Nevertheless, valuation metrics in some sectors do appear substantially stretched -- particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.

That sounds reasonable enough, if you accept the initial premise that each group, separately, is already stretched. Not everyone does, however.

Last week, ISI Group biotechnology and pharmaceuticals analyst Mark Schoenebaum penned an open letter to Fed Chairwoman Janet Yellen, disputing the central bank's evidence:

You stated that biotechnology valuations are "stretched, with ratios of prices to forward earnings remaining high relative to historical norms." I just gathered biotech price to earnings ratios back to 1993 using Russell 1000 data, and my data show that the current ratio is roughly in-line with the historical median and is approximately 80% below the peak. Please tell me what I'm missing, Dr. Yellen.

Note, however, that Schoenebaum does not argue that biotechnology stocks are not overvalued, simply that the Fed's supporting statement that price-to-earnings multiples in the sector are high relative to historical norms is inaccurate. In an email to clients, he clarified his position:

I'm not arguing that biotech is "cheap." Rather, I'm arguing that there is little empiric evidence to support the conclusion that we are in a valuation "bubble."

By and large, as a value-driven skeptic, I would tend to side with the Fed in this debate. It's my understanding that the biotechnology sector has reliably destroyed tens of billions of dollars of shareholder value over decades -- the high-technology equivalent of airlines. However, I was surprised to find that the Nasdaq Biotechnology Index has produced a 13.5% annualized price return over the 10-year period ending June 30, which compares very favorably with the S&P 500's 5.6% return (dividends wouldn't come close to making up the difference). Furthermore, Schoenebaum's graph shows that the biotechnology sector sported a higher price-to-earnings multiple at the start of that period than it does now.

Nevertheless, while the sector as a whole may not be overvalued, individual biotechnology stocks -- particularly small caps -- are speculative. That doesn't rule them out of your portfolio per se, but no one should ignore that situation.

Leaked: This coming blockbuster will make every biotech jealous
The best biotech investors consistently reap gigantic profits by recognizing true potential earlier and more accurately than anyone else. Let me cut right to the chase. There is a product in development that will revolutionize not just how we treat a common chronic illness, but potentially the entire health industry. Analysts are already licking their chops at the sales potential. In order to outsmart Wall Street and realize multi-bagger returns you will need The Motley Fool's new free report on the dream-team responsible for this game-changing blockbuster. CLICK HERE NOW.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers