Biotech stocks have delivered sizzling overall returns over the last few years. New drugs have improved the lives of patients and made big profits for investors in the process.

The future looks promising for biotech stocks as a group as well. Several currently successful drugs have room to increase sales. Even more powerful drugs are on the way. But which biotech stocks are the best choices for investors to buy in 2019?

Test tubes with increasingly higher levels of green fluid with a green arrow trending upward in the background

Image source: Getty Images.

What are biotech stocks?

What exactly is a biotech? The term is short for "biotechnology," which includes any type of technology that involves the use of living organisms to develop agricultural or medical products.

Many medicines don't involve the use of living organisms. Medicines that do are called biologics. Technically, only drugmakers that develop biologics are biotechs. However, the term "biotech" is frequently used to refer to drugmakers that develop traditional nonbiologic drugs as well.

All drugmakers follow the same general path for drug development and approval. They must adance a biologic drug from preclinical testing to clinical testing. Typically, clinical testing involves three phases of clinical studies. After successful completion of phase 3 clinical testing, the company can submit for regulatory approval of its experimental drug. 

There are several key differences, though, for biologics. The manufacturing process for biologics is typically much more complicated than the manufacturing process for other drugs. Also, instead of filing a New Drug Application (NDA) for regulatory approval by the U.S. Food and Drug Administration (FDA), biotechs must file a Biologics License Application (BLA). Probably the most important difference between biologics and other drugs is the length of exclusivity -- a period where a brand drug is protected from competition from generic versions.

Traditional drugs are usually given five years of exclusivity in the U.S. before a generic version can enter the market. Biologics don't have generic versions, but they can have biosimilars -- another biologic for which there isn't a clinically meaningful difference from the reference product. Biologics enjoy a 12-year period of exclusivity in the U.S. before biosimilar competition is allowed. Most drugmakers of either biologics or other drugs secure patents for their products that, if successfully defended, can hold off competition even longer. 

What to look for in biotech stocks

Investors considering buying a biotech stock need to evaluate the potential of its current products and its pipeline -- the portfolio of the biotech's experimental drugs in development. Evaluating the former is significantly easier to do than the latter.

For already-approved products, you'll definitely want to look at sales growth. It's the best way to determine how strong a biotech's current product lineup is. However, you'll also need to get a sense of how sustainable a product's sales growth actually is.

One important thing to consider is how many years of exclusivity the drug has remaining. Sales tend to fall off dramatically once generic or biosimilar rivals are on the market. Check out current competitive drugs, too. Even if the biotech's top drugs have several years left of exclusivity, the emergence of strong branded rivals can hurt sales growth.

It can be tricky to assess how strong a biotech's pipeline is. Even promising candidates can fail in clinical studies or in the regulatory approval process. However, the odds of success are greater for late-stage drugs than they are for early-stage drugs.

Pay especially close attention to previous clinical results for a biotech's phase 3 candidates as well as to already-approved drugs and pipeline candidates of other biotechs targeting the same indications. A biotech with multiple late-stage pipeline candidates that performed really well in previous clinical studies and that have few or no strong rival drugs on the market or in development is more likely to be successful.

While revenue is certainly important, investors will also need to examine biotechs' earnings and cash positions. A biotech stock that has reported positive earnings growth for several consecutive quarters and that has a cash stockpile large enough to fund operations for a year or more will be less risky than a biotech stock that doesn't meet these criteria.

As with any stock, valuation is another key factor to consider with biotech stocks. Because the best biotech stocks should deliver solid growth, metrics based on projected earnings such as the forward price-to-earnings multiple and the price-to-earnings-to-growth (PEG) ratio, which incorporates earnings growth expectations, are better for assessing the valuation of these stocks than historical measures such as the trailing-12-month price-to-earnings (P/E) ratio.

Top 5 biotech stocks for 2019

The best biotech stocks have successful products on the market that are generating tremendous sales growth. They're profitable with solid earnings growth and they have strong pipelines.

Here are the top biotech stocks to buy in 2019:

Company Market Cap Forward P/E Ratio
AbbVie (NYSE:ABBV) $121.6 billion 8.57
Celgene (NASDAQ:CELG) $63.5 billion 7.23
Exelixis (NASDAQ:EXEL) $6.7 billion 17.26
Ligand Pharmaceuticals (NASDAQ:LGND) $2.6 billion 18.15
Vertex Pharmaceuticals (NASDAQ:VRTX) $48.1 billion 29.11

P/E = price to earnings. All data as of Feb. 18, 2019. Data source: Yahoo! Finance. 

1. AbbVie

AbbVie's Humira is the best-selling drug in the world, having raked in a whopping $19.9 billion in 2018. The company also has two other blockbuster drugs (drugs that achieve annual sales of $1 billion or more) with cancer drug Imbruvica and hepatitis C virus (HCV) drug Mavyret. 

In addition to these top-tier drugs, AbbVie also has several other products that generate significant revenue. Sales for leukemia drug Venclexta are rapidly picking up momentum. Creon and Lupron have been on the market for years but their sales continue to grow. The biotech also has a promising new endometriosis drug approved in 2018, Orilissa, for which sales are starting to ramp up.

Overall, AbbVie's revenue grew 16% year over year in 2018. The company's adjusted earnings per share (EPS) increased by 41% compared to the same period last year.

The biggest challenge for AbbVie's current product lineup relates to the company's dependence on legacy drug Humira, which is responsible for nearly 61% of AbbVie's total revenue last year. Biosimilars to Humira hit the European market in October 2018 and have already begun to chip away at the blockbuster drug's market share. AbbVie will begin facing biosimilar competition in the U.S. in 2023.

However, AbbVie isn't too worried about sales declines for Humira in large part because of its promising pipeline. The biotech is conducting phase 3 clinical studies for several existing drugs in treating additional indications, including Imbruvica, Orilissa, and Venclexta. AbbVie also has several promising new late-stage candidates. Immunology drugs risankizumab and upadacitinib especially stand out. AbbVie expects the two therapies combined will make at least $10 billion annually by 2025. 

AbbVie reported cash, cash equivalents, and short-term investments totaling nearly $8.8 billion as of Sept. 30, 2018. This cash stockpile gives the company plenty of flexibility to make acquisitions in the future if it chooses to do so. AbbVie also pays a dividend that yields more than 5%, and its low forward P/E ratio of 8.57 makes the stock a bargain compared to many other stocks. 

2. Celgene

Celgene's top product, blood cancer drug Revlimid, is also one of the best-selling drugs in the world. Last year, Revlimid generated sales of nearly $9.7 billion, up 18% over 2017.

The biotech's other key products include multiple myeloma drug Pomalyst, immunology drug Otezla, and cancer drug Abraxane. Sales for Pomalyst and Otezla grew 26% year over year in 2018, while sales for Abraxane increased more than 7%. Celgene's total revenue grew by nearly 18% last year. The biotech's adjusted EPS increased by 20% in 2018.

Like AbbVie, Celgene depends heavily on one product -- in this case Revlimid, which kicks in around 63% of total sales. Also like AbbVie, Celgene faces loss of exclusivity for its best-selling product in the near future. A generic version of the drug will be available in limited volumes beginning in 2023 with no volume restrictions after Jan. 31, 2026. 

But Celgene's pipeline appears to be very strong. The company is waiting for FDA approval of fedratinib in treating myelofibrosis. It expects to file for approval for ozanimod in treating multiple sclerosis soon. Celgene also expects to win regulatory approvals for blood disorder drug luspatercept and cancer-fighting cell therapies bb2121 and liso-cel by 2020. All five drugs are projected to be blockbusters if they succeed.

Celgene appears to be in solid shape financially as well, with a cash stockpile of $6 billion. And it's practically a steal with shares trading at a little over seven times expected earnings.

Bristol-Myers Squibb (NYSE:BMY) found Celgene so attractive that it's trying to acquire the biotech. If the acquisition is accepted by regulators and shareholders of both companies later this year, Celgene shareholders would realize a nice gain of close to 17%. In addition, they'll receive a contingent value right (CVR) share, which will entitle the holder to receive $9 in cash per share for the achievement of future regulatory milestones for ozanimod, liso-cel, and bb2121. 

3. Exelixis

Exelixis currently has four approved products: cancer drugs Cabometyx, Cometriq, and Cotellic, and hypertension drug Minnebro, which is approved in Japan. The most important drugs for the biotech are Cabometyx and Cometriq, which are different forms of cabozantinib.

Last year, Exelixis reported 90% revenue growth. Much of this growth was driven by momentum for Cabometyx in treating advanced renal cell carcinoma (RCC), the most common type of kidney cancer. The biotech's adjusted EPS in 2018 nearly tripled from the previous year mostly due to the success of Cabometyx.

Although the FDA's five-year exclusivity period for Cabometyx began in 2016, Exelixis won't have to worry about generic competition for its key drug for a while. The company has an array of U.S. patents that begin expiring in 2024, with the last of the patents extending through 2033. 

Exelixis' sales should receive a big boost from the FDA's January approval for the drug to be used as a treatment for previously treated advanced hepatocellular carcinoma (HCC), the most common type of liver cancer. The drug also won approval for this indication in Europe in November 2018. 

More indications for cabozantinib could be on the way. Exelixis is conducting a phase 3 clinical studies evaluating the drug in treating thyroid cancer and in previously untreated advanced HCC. CEO Michael Morrissey also stated in the biotech's fourth-quarter 2018 earnings conference call that Exelixis plans to boost its pipeline with additional assets.

The company had a cash position totaling nearly $852 million at the end of 2018. Exelixis stock might not look like a tremendous bargain with a forward P/E of over 17. However, the future growth prospects for Cabometyx give the stock a very attractive PEG ratio of 0.48.

4. Ligand Pharmaceuticals

Ligand Pharmaceuticals is a unique biotech. It doesn't actually develop drugs on its own. Instead, Ligand develops platforms that it licenses to drugmakers to help them develop drugs more effectively.

There are currently 10 products on the market that use Ligand's technologies. These products include Amgen's multiple myeloma drug Kyprolis and Novartis' Promacta, which increases blood platelet counts for patients with several diseases.

Business is booming for Ligand. In 2018, the biotech reported a revenue increase of 78%. Ligand's adjusted EPS soared more than tenfold year over year.

Eight experimental drugs that use Ligand's technologies are in late-stage clinical testing or awaiting regulatory approval. One especially promising candidate in this group is Sage Therapeutics' postpartum depression drug Zulresso (brexanolone), which received FDA approval decision on March 19, 2019. 

The earlier-stage pipeline looks even more encouraging. Twenty-one drugs that use Ligand's technologies are currently in phase 2 testing, with another 23 in phase 1 clinical trials

Ligand had more than $718 million in cash at the end of 2018. Like Exelixis, Ligand's valuation could seem a little high based on its forward P/E multiple of 18.15. But Ligand claims an attractive PEG ratio 0.8 thanks largely to the solid growth prospects for the pipeline candidates using its technologies.

5. Vertex Pharmaceuticals

Vertex just might be the best biotech stock on the market right now. The company's three approved drugs -- Kalydeco, Orkambi, and Symdeko -- enjoy a virtual monopoly in treating the underlying causes of a genetic disease called cystic fibrosis (CF).

Sales for these three drugs soared last year, driving Vertex's revenue up 22%. The biotech's adjusted EPS more than doubled from 2017.

Vertex doesn't have to worry about generic competition for a long time. The company's U.S. patents on Kalydeco and Symdeko don't expire until 2027, while its patent on Orkambi extends through 2030. 

There's a very good chance that Vertex will add another drug to its portfolio in 2020. Vertex plans to submit for regulatory approval of a triple-drug combination therapy for CF by mid-2019. If approved, this therapy along with securing approvals for its current drugs in treating younger CF patients could enable Vertex to expand its addressable market by nearly 75%. 

Vertex's pipeline also includes promising drugs targeting other indications. None are yet in late-stage testing. However, the biotech plans to advance experimental pain drug VX-150 into phase 3 clinical studies after it completes a phase 2b dose-ranging study. Vertex also has several early-stage clinical programs, notably including partnering with CRISPR Therapeutics on gene-editing therapy CTX001.

The company's cash position continues to improve, with Vertex reporting nearly $3.2 billion in cash, cash equivalents, and marketable securities at the end of 2018. Vertex has a similar story with respect to valuation as Exelixis and Ligand. Although Vertex's forward P/E is higher than 29, its PEG ratio is a relatively low 0.8.

What are the risks to biotech stocks?

All five of these biotechs, as well as the greater biotech industry, face several risks, with the greatest one being that a key pipeline candidate fails in a clinical study. AbbVie experienced a big clinical setback last year with experimental cancer drug Rova-T. Celgene's once-promising Crohn's disease drug GED-0301 flopped in a late-stage study in 2017.

Even if clinical testing goes well, there's also a possibility that regulatory agencies could decide not to approve a drug. Celgene had an embarrassment in early 2018 where the FDA refused to review its regulatory submission for ozanimod. The biotech had to add more data to its filing and plans to resubmit for approval in the first quarter of 2019. Such delays can be costly, especially for a drug like ozanimod with the potential for blockbuster sales.

You might think that the biotechs would have clear sailing as long as there aren't any serious clinical or regulatory setbacks, but that's not necessarily the case. There's always the chance that another drugmaker could develop a more effective product. New products that are comparable in efficacy could cause a competitive battle that results in loss of market share and price cuts that hurt growth prospects. AbbVie and Celgene face the potential threats that their respective top-selling drugs could lose in litigation over patents. Should Humira face generic competition in the U.S. sooner than expected, it would likely take a big toll on AbbVie's share price. The same is true for Celgene with a generic rival for Revlimid.

Celgene's pending acquisition by Bristol-Myers Squibb also presents a unique risk for the biotech. If the deal falls through, it's likely that Celgene's stock would fall, too.

Bright futures

Although they all carry risks, all five of these biotechs should have bright futures.

AbbVie and Celgene appear likely to profit from their top blockbuster drugs for several more years as their other approved drugs and new drugs potentially on the way generate growth. Exelixis, Ligand, and Vertex stand to expand their markets with new indications and new therapies. Strong current lineups and promising pipelines combined with solid financial positions make these biotechs good picks for investors in 2019.