Yellen Hates Biotech Stocks! Should You?

Are big biotechs -- Amgen, Biogen Idec, Gilead Sciences, and Celgene -- really overvalued, or is the Fed chairwoman looking at smaller companies?

Jul 21, 2014 at 2:01PM

Federal Reserve Chairwoman Janet Yellen thinks your small-cap biotech is overvalued. The Fed's Monetary Policy Report, released on July 15, had this to say:

[V]aluation 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.

It's not clear from the statement exactly what valuation metrics the Fed is using. It certainly isn't P/E, since most small-cap biotech companies aren't profitable. Only about 20% of the 110 drug companies in the CAPS database with market caps between $250 million and $1 billion were profitable last year. And at least some of those -- Albany Molecular Research and PetMed Express, for instance -- I wouldn't call biotech companies.

Later in the report, the Fed seemed to throw the entire sector into the overvalued category.

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.

Let's ignore for a second that forward P/E is a dangerous measurement since it relies on analyst expectations. Here's a chart of the forward P/Es of the four big biotechs: Amgen (NASDAQ:AMGN), Biogen Idec (NASDAQ:BIIB), Gilead Sciences (NASDAQ:GILD), and Celgene (NASDAQ:CELG).

GILD PE Ratio (Forward) Chart

GILD P/E Ratio (Forward) data by YCharts.

Call it a mixed bag, with Celgene and Biogen Idec now above their historical P/Es and Gilead Sciences and Amgen not looking particularly overvalued at the moment. But since these are dependent on analyst expectations, they can change rapidly, as the recent drop in Gilead's forward P/E shows.

What I think Yellen and her comrades are really worried about is the substantial increase in values, especially in the small-cap space, over the last few years. We've pulled back from the highs set earlier this year, but values are still up substantially compared to the S&P 500.

XBI Chart

XBI data by YCharts.

In biotech, valuation is determined by risk tolerance. I think the increase over the last two and half years has more to do with valuations being out of whack at the beginning of 2012 as investors weren't willing to take on risk, rather than with investors taking on too much risk now.

Biotech isn't a steal, either
There are many different ways to value development-stage biotechs. I prefer to make an educated guess at the potential values after the next binary event, and then determine whether the probability of success for the binary event makes it worth the risk. See this video for more details.

Every drug is going to have a different likelihood of success based on the clinical data available, and there's a lot of educated guessing with the potential valuations, making it hard to do a systematic approach to determine whether biotechs are overvalued (i.e., investors aren't being rewarded for the risk they are taking). But my feeling after covering this industry for nearly a decade is that Yellen is right to some degree that valuations are a little higher than they should be -- albeit not for every company.

One way to not take on risk that outpaces the potential reward is to look a little longer term. When biotech becomes overheated, investors want their money working right now, so companies with the most immediate binary events get bid up in the frenzy. If you're willing to buy and hold -- at least for the medium term -- there are still some deals out there. And being patient allows you time to buy on dips.

You know, like when the Fed chief says the sector is overvalued.

Getting ahead of the curve
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.


Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Celgene and Gilead Sciences and owns shares of Gilead Sciences. 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 www.fool.com/podcasts.

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 www.fool.com/podcasts, 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