What happened

A handful of genetic testing stocks rolled off all-time highs last month. Shares of NeoGenomics (NASDAQ:NEO) led the peer group by shedding 23.5% in September, according to data from S&P Global Market Intelligence. That was closely followed by a tumble of 20.6% for shares of Invitae (NYSE:NVTA) and a decline of 11.5% for Genomic Health (NASDAQ:GHDX).

There wasn't any major news for the group. It appears that last month's poor performance was simply a case of reduction of market valuations that were at or near all-time highs at the beginning of September. While a falling stock price isn't what shareholders want to see, each of the three companies is well positioned to grow into its premium valuation.

A declining chart on a chalkboard.

Image source: Getty Images.

So what

The genetic testing industry has experienced major changes in the past five years. After previously relying on selling low volumes of high-priced tests for specific cancers and diseases, the default business model has evolved to focus on selling high volumes of affordable tests for diagnosing a broad set of cancers and diseases. The evolution has been made possible by lower-cost sequencing and better data analytics, which has also helped to improve the quality of the products and services offered.

It took time to reach adequate levels of scale, but a handful of genetic testing companies are now consistently profitable. Genomic Health delivered an operating margin of 12% in the first half of 2019 while still managing to grow revenue 18% from the year-ago period. NeoGenomics has found it a little more difficult to achieve high margins, but the business is profitable, growing, and cash flow positive. 

Invitae was inching closer to positive operating margins but decided earlier this year to go all-in on growth. After achieving $94 million in revenue in the first half of 2019, management thinks it can achieve $500 million in total revenue in 2020. That will require a huge step-up in growth and success with an unproven clinical model for genetic testing orders, but Wall Street has gone along with the vision so far despite massive losses.   

First-Half 2019 Operating Metric

Genomic Health

NeoGenomics

Invitae

Market cap*

$2.6 billion

$2.1 billion

$1.8 billion

Revenue

$223 million

$197 million

$94.0 million

Operating income

$27.0 million

$7.0 million

($88.1 million)

Operating cash flow

$34.7 million

$1.4 million

($61.1 million)

Cash balance

$243 million

$167 million

$247 million

Data source: SEC filings. * = Market cap on Oct. 4, 2019.

All three companies will report third-quarter 2019 operating results in late October or early November. Investors have a few things to keep an eye on with each company:

  • Genomic Health: Aside from continuing on a profitable growth trajectory, investors will be eager to learn more details of the proposed acquisition by Exact Sciences. The deal is expected to close by the end of 2019 and could result in combined annual revenue of $1.6 billion and gross profit of $1.2 billion in 2020. 
  • NeoGenomics: The company needs to continue extracting growth from and reducing the operating expenses of its recently acquired Genoptix unit. The ongoing integration will play a significant role in driving operating margins higher.
  • Invitae: The high-growth strategy will keep getting more expensive. Management told investors that the business could report a cash burn as high as $150 million in 2019. Investors need to remain vigilant that the strategy is worth the cost.

Now what

Even after tumbling in September, these three genetic testing stocks are still close to all-time highs. Investors should expect them to remain volatile for the foreseeable future as growth leads to premium valuations, and premium valuations get adjusted lower when they get too frothy.