You might look at Vertex Pharmaceuticals (VRTX 2.86%) stock and shake your head at its valuation. After soaring more than 70% so far in 2017, shares of the biotech now trade at a whopping 180 times trailing-12-month earnings. That's the kind of price tag that would cause Warren Buffett's mentor Benjamin Graham to spin in his grave.
Should this make you stay away from Vertex? I don't think so. Here's why you're smart to buy the biotech stock even at its seemingly stratospheric valuation.
First of all, I'm not a fan of basing valuation on trailing earnings multiples. The stock market doesn't care much about what's in the rearview mirror. More important in Vertex's case, though, is that most of the biotech's earnings over the last 12 months came in the first quarter of 2017. The trailing multiple doesn't reflect the momentum that Vertex -- and especially its cystic fibrosis (CF) drug Orkambi -- have.
Vertex stock is still pricey looking forward, with shares trading at 41 times expected earnings. However, that's much less scary than the stock's trailing earnings multiple. Granted, a danger in using forward earnings multiples is that growth projections can be way off target. I don't think that's the case for Vertex, however.
The company appears to be on track with lining up reimbursement for Orkambi in European countries, a major prerequisite for strong earnings growth over the next 12 months. Vertex announced finalization of a reimbursement agreement in Ireland on June 1. The company reported on July 13 that it had also secured a reimbursement deal for Orkambi in Italy.
Just wait 'til next year
There's an even greater opportunity for Vertex than Orkambi that could be on the way. In March, Vertex announced positive results from two late-stage studies of a combination of tezecaftor and Kalydeco in treating CF. Based on these results, the biotech plans to submit the combo for approval in the U.S. and Europe within the next few months. That could put Vertex on track to win a green light to go to market next year.
Even though Orkambi has been and should continue to be a huge success, the drug does have a drawback. Some patients have discontinued taking Orkambi due to respiratory adverse events. Concerns about reports of these discontinuations was a key factor behind Vertex stock's poor performance last year.
The tezecaftor/Kalydeco combo doesn't appear to have the negative side effects that Orkambi can have. Vertex reported that the rates of patient discontinuations were low and similar to the placebo groups in both late-stage studies of the combination therapy.
Vertex thinks that this new combo, along with label expansions for Kalydeco and Orkambi, will be a key growth driver in the near future. There are currently around 29,000 CF patients that are eligible for treatment with Kalydeco and Orkambi. Vertex hopes to increase that target population to 44,000 patients if it's able to win regulatory approval for the new two-drug combo and label expansions for current drugs.
The long-term perspective
Over the longer term, Vertex's prospects look even better. Positive results from the two-drug combo of tezecaftor and Kalydeco could bode well for the biotech's three-drug CF combos in development.
Vertex expects to announce results in the second half of 2017 from three clinical studies of three-drug combination therapies. Two of those combos are in phase 2 studies and have already secured fast track designation from the Food and Drug Administration, which could facilitate a speedier approval process.
These triple-drug regimens are critical for Vertex's future growth. If they're successful, the company projects that its target CF population could increase to 68,000 patients. That would leave around 7,000 CF patients in North America, Europe, and Australia without an approved treatment. But Vertex has a plan to help those patients as well.
In 2015, Vertex forged a deal with CRISPR Therapeutics (CRSP -0.56%). The two partners are collaborating on the treatment of CF using CRISPR-Cas9 gene editing, one of the most exciting and promising technologies ever. Vertex and CRISPR are also looking at using gene editing to treat sickle cell disease.
Vertex could have competitors down the road. Galapagos (GLPG) is active in CF drug development. However, the Belgium-based biotech doesn't plan to even start testing of a three-drug combo until the fourth quarter of this year. That means Vertex has a considerable head start.
Novartis (NVS 1.08%) also has an experimental CF drug in phase 2 -- QBW251. That study isn't expected to wrap up until 2019. The big pharmaceutical company terminated another phase 2 study of QBW251.
Thanks to its leg up over these potential rivals, analysts project that Vertex will be able to grow earnings by an average annual rate of more than 60% over the next five years. If the biotech can achieve this growth (and I think it can), buying Vertex stock now should prove to be a smart decision over the long run.