This Just In: More Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given that, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the worst ...
It's not unanimous yet, but it's getting there. Yesterday, another analyst boarded the Provenge bandwagon, when Collins Stewart echoed Deutsche Bank's Dendreon (Nasdaq: DNDN) upgrade of last year -- then nearly tripled it.

Yester-year, as you may recall, Deutsche predicted that Dendreon's new prostate cancer drug had a potential $1.3 billion market outside U.S. borders -- a number considerably above the Wall Street consensus at the time. Yester-day, Collins clambered even further out on a limb, arguing that by 2020, Dendreon could be raking in as much as $3.1 billion in Provenge sales. According to the analyst, the EU is likely to approve Provenge for use in treatment of castrate-sensitive prostate cancer sometime in mid-2013, helping transform Dendreon into a bona fide "leading mid-cap biotech company." But even before that happens, Collins argues, we could see Provenge sales hit $371.4 million this year -- "with possible upside."

Accordingly, Collins believes Deutsche's $44 price target on the stock is too conservative, and that Dendreon's worth $55, minimum. But is it right?

Let's go to the tape
I wish I could tell you it is, but I fear the facts argue otherwise. Consider, for example, Collins Stewart's record to-date on similar biotech industry picks:

Like Dendreon, each of these three stocks possesses a fervent throng of investors hoping for big gains. Like Dendreon, they all have products on the market; no longer mere "startups," they're actually selling goods and generating revenues. Also like Dendreon, they possess ample war chests flush with cash, and little (or in Human Genome's case, not-too-awful-much) debt on the balance sheet. And like Dendreon ... not a one of 'em is profitable today.

The downside to Dendreon
What this means, unfortunately, is that investors in these profitless biotechs are basically forced to invest in a dream, valuing the companies more on the sales they make, and hope to make, than on their potential to reap profits from such sales. And that is a problem.

Consider: Your average big-name, big-profits Big Pharma concern (think Pfizer (NYSE: PFE), Merck (NYSE: MRK), or Johnson & Johnson (NYSE: JNJ)) sells for somewhere in the neighborhood of 2.2 to 2.6 times annual sales. (And remember -- this is the price for profitable companies.) In contrast, up-and-comers like Isis, Savient, Human Genome, and Dendreon fetch P/S ratios ranging anywhere from eight times sales (Isis) to 180 times sales (Savient). Dendreon isn't the most expensive stock on this list, but at a share price equal to 108 times the amount of sales it generated in the past year, neither is it cheap.

But it's got potential, right?
Sure it's got potential. In fact, Collins Stewart believes that "robust patient/physician demand" is causing Dendreon to embark upon a program to "increase Provenge manufacturing capacity tenfold in 2011." (As fellow Fool Brian Orelli points out, however, so far Dendreon only has FDA approval to increase production four-fold. It's still waiting on approval for two final sites that will make the tenfold increase a reality.)

Even if we assume that all goes as planned, and production ramps as Dendreon intends, this poses a problem: Even optimistic analysts doubt Dendreon can earn enough this year to bring its P/E ratio down from "infinity" to anything less than 98 times earnings. Longer-term, they expect to see little or no earnings growth at the company for the next five years.

Foolish final thought
And that's the good news. The bad news is that expanding manufacturing capacity costs money today. Dendreon's capacity expansion has already consumed massive amounts of cash -- $408 million in negative free cash flow last year alone. Increasing capacity tenfold is only going to increase the rate of cash burn in the near term. Result: The company has had to float $540 million worth of convertible debt to finance the project.

Granted, Dendreon needed the cash to expand capacity as planned. Also granted, Dendreon got a good interest rate on the debt (2.9%). So maybe the debt-bet will ultimately pay off for Dendreon, if Provenge proves as profitable as hoped. But at 99 times forward earnings, I wouldn't bet on the stock's rewarding investors.