Over the 13-year period covering the end of the 2008 financial crisis until the fourth quarter of 2021, the biotech industry as a whole crushed the performance of most major U.S. stock indexes. This prolonged bull market was fueled by a mix of tailwinds such as record low interest rates, massive fiscal stimulus by the U.S. government, and the insights and discoveries flowing out of the human genome project.
Biotech's dizzying pace of innovation during the prior decade produced numerous game-changing novel modalities, such as viable antibody drug conjugates, checkpoint inhibitors, genetically engineered cellular therapies, new and improved enzyme replacement therapies, functional cures for infectious diseases like hepatitis C, and many others. The net result is that scores of once completely undruggable diseases, or nearly impossible-to-treat indications, came to heel under biotech's innovation bonanza.
However, biotech's rampaging growth story came to an abrupt halt during the fourth quarter of 2021. With the prices of consumer goods skyrocketing over the past few quarters, it became readily apparent that the Federal Reserve would have to tighten its fiscal policies in order to reign in inflation. And with borrowing costs poised to rise in 2022, investors suddenly lost their appetite for risky growth stocks. Speaking to this point, the SPDR S&P Biotech ETF, which tracks the performance of mostly small- to mid-cap biotech companies, has been undergoing a lightning-quick drawdown since the final quarter of 2021.
One of the most intriguing aspects of this broad-based sell-off is that well over 100 publicly traded biotech companies are now being valued at less than cash on hand. What's more, almost every single clinical-stage biotech is currently being valued at a mere fraction of the commercial potential (aka deep value) of its lead drug candidate. Even the top late-stage clinical candidates of blue chip biotechs like Amgen (AMGN -0.50%), Bristol Myers Squibb (BMY 0.96%), and Gilead Sciences (GILD -1.15%) don't appear to have much, if any, discernible value in the eyes of this moody market. All that seems to matter, from the market's vantage point, is the cold, hard cash flowing through a biotech right this instant.
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Why the market has zero faith in biotech's deep value proposition
Deep value is the lifeblood of biotech, especially among clinical and/or early commercial stage companies. Pre-revenue companies rely heavily on the promise of surging future sales to attract investors. In brief, these cash-flow-negative businesses have to be able to convince shareholders to stay the course through multiple public offerings in order to fund costly clinical trials, push drugs through the lengthy regulatory review process, and to pay for a newly approved drug's commercial launch.
Unfortunately, developmental and single-drug biotech companies face a multitude of risk factors. First and foremost, the vast majority of experimental drugs simply fail in the clinic. And even when these research and development outfits do land a winner in the clinic, they often lack the experience necessary to shepherd a drug through the onerous review process in a timely manner. Regulatory delays can be seriously bad news for late-state biotechs, given that an extended regulatory cycle allows potential competitors time to play catch-up.
Lastly, the bulk of newly minted commercial-stage biotechs simply don't have the resources to drive the rapid adoption of a novel medication, or even to properly defend their intellectual property rights from the threat of generic competition. It is not enough to have a best-in-class therapy. A biotech must also have the commercial and legal infrastructure to get the most out of its flagship products.
Growth investors were apparently willing to overlook these built-in risks during the era of easy money, so to speak. But with interest rates on the rise and the costs of borrowing set to follow suit, the market is clearly taking a far different stance toward biotech's deep value proposition right now.
How investors can beat the biotech bear market
The market's dire take on clinical assets won't last forever. That's the good news. But if you want to build a winning biotech portfolio in this extreme environment, you may want to load up on large-cap companies with attractive valuations, strong free cash flows/revenue streams, and an above-average dividend. Fortunately, Amgen, Bristol Myers Squibb, and Gilead Sciences tick all of those boxes.
Specifically, Amgen's shares are currently trading at roughly 12 times forward earnings, which is well below average for a Nasdaq-listed blue chip stock. The biotech's top line is also projected to rise by a respectable 4.1% in 2022 and it offers a sizable annual dividend yield of 3.4% right now.
Bristol's shares are presently among the cheapest in the space at 7.78 times forward-looking earnings. What's more, the drugmaker's top line is expected to grow at above-average levels starting in the second half of the decade. On the dividend side of things, its annual dividend yield currently stands at 3.38%, which is slightly above average for its immediate peer group.
Gilead Sciences stock, for its part, is a downright bargain at under 10 times forward-looking earnings. The biotech also pays out one of the industry's higher dividends at 4.12% on an annualized basis. Now, Wall Street is expecting Gilead's top line to soften this year due to anticipated decline in demand for the COVID-19 drug Veklury. But the biotech giant has several new growth products on tap that ought to reverse this trend in the near future.
All told, these three blue chip biotechs should be able to weather this moody market to deliver respectable gains for investors in 2022.
