You expect a top-ranked football team to play well every game. You expect the Kentucky Derby winner to place in the Preakness Stakes. And you expect a stock with a high valuation to generate strong sales and earnings growth every quarter.
Three healthcare stocks are especially priced for perfection right now: Exelixis (EXEL 0.53%), Illumina (ILMN -2.86%), and Veeva Systems (VEEV -0.62%). What gives these stocks such premium valuations? And more importantly, can they continue to deliver for investors?
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Exelixis
Exelixis claims a ridiculously high earnings multiple of 143. However, that ratio is based on the biotech's earnings over the last 12 months. Exelixis stock trades at nearly 43 times expected earnings -- still giving the stock a steep valuation.
Investors have great expectations for Exelixis' cancer drug Cabometyx. The drug has already captured 35% of the market as a second-line treatment for renal cell carcinoma (RCC), the most common type of kidney cancer. Exelixis awaits approval for an even bigger market as a first-line treatment for the disease.
However, Exelixis will have competition. Bristol-Myers Squibb (BMY -0.52%) recently announced results from its late-stage study of Opdivo and Yervoy as a first-line treatment for RCC. Even Exelixis CEO Michael Morrissey called those results "a clear win" for Bristol-Myers Squibb.
Exelixis faces two primary hurdles to avoid a stock meltdown: win approval for Cabometyx in the first-line RCC indication, and succeed commercially. There is certainly some risk that the biotech won't deliver. However, I think Exelixis has pretty good odds for achieving both goals. I also expect Exelixis could find itself an acquisition target down the road.
Illumina
Illumina stock currently trades at nearly 46 times expected earnings after soaring close to 60% so far this year. That's even steeper than its trailing-12-month earnings multiple of 41. Why has the market rewarded Illumina with such a lofty valuation? The company dominates the gene-sequencing market.
But Wall Street analysts only project annual earnings growth for Illumina of around 15% over the next five years. That doesn't seem to be sufficient growth to justify the stock's sky-high price. Could Illumina be in a bubble that's about to pop? I don't think so.
For one thing, Wall Street might be too conservative about the company's prospects. Illumina's new NovaSeq system has wowed current customers. The company expects to flip most of its HiSeq high-throughput gene-sequencing system users to NovaSeq over the next few years. Even better news, though, is that NovaSeq is expanding the market to organizations that couldn't have afforded gene sequencing in the past.
There's also history to consider. Illumina stock has always enjoyed a premium valuation. For most of the last decade, shares have traded at even higher earnings multiples than they do now. And that was before the prospects of NovaSeq bringing in a new wave of customers came along. Illumina could experience bumps along the way, but my view is that this stock will remain a winner over the long run.
Veeva Systems
A forward earnings multiple of 55 gives Veeva Systems stock what could legitimately be called a nosebleed valuation. Veeva's share price means even seemingly perfect results might not be enough to please investors.
As a case in point, Veeva posted terrific numbers in its second-quarter results. Revenue was up 27%. Adjusted earnings soared 61%, easily beating expectations. Veeva even provided third-quarter and full-year revenue and earnings guidance that topped Wall Street projections. But the stock price still sank like a brick.
Despite the big pullback, though, Veeva Systems stock is still up close to 40% year to date. More importantly, its long-term prospects are as bright as ever. The company provides a growing number of cloud-based software applications to the life sciences market. These applications are quite "sticky," meaning that once customers select Veeva, they're likely to stay with Veeva.
The company is also eyeing markets outside of the life-sciences industry. Veeva signed up a major consumer packaged goods customer earlier this year. Expansion into other markets could be a huge opportunity for driving growth in the future. Veeva Systems stock is priced for perfection, but it also has a business model that's pretty close to perfect.
