What's the one financial metric to look at first when evaluating a stock? Many investors point to return on equity, or ROE. This measurement reveals a company's profits as a percentage of total shareholder equity. The best way to use ROE is to compare one company's value against others in the industry. Stocks with higher returns on equity tend to be better picks.
If you're looking to find a stock in the sizzling hot world of biotechs, you won't find a huge pool of high ROE possibilities. That's partially because many biotechs don't have profits yet. However, there are still several strong candidates. Here are three biotech stocks with the best return on equity.
1. Medivation (NASDAQ:MDVN)
Medivation boasts the most impressive trailing 12-month ROE of any biotech -- a whopping 103.8%. The biotech scored the top spot thanks to prostate cancer drug Xtandi, which generated worldwide sales of $1.1 billion last year. Medivation splits that revenue, however, with collaboration partner Astellas Pharma.
It wasn't long ago (2013, to be precise) that Medivation was among the many biotechs still awaiting profitability. As Xtandi's sales increased and large milestone payments began flowing from Astellas, though, Medivation achieved a banner year in 2014.
Will Medivation be able to keep its top ROE ranking? Maybe not. For one thing, the biotech reported a GAAP loss in the first quarter this year. Meanwhile, Medivation's shareholder equity is increasing. Those two factors, if they continue, will certainly bring the company's ROE down from its stratospheric levels.
On the other hand, multiple clinical trials are under way for Xtandi in treating other stages of prostate cancer and breast cancer. Should Medivation win regulatory approval for other indications, there's a good potential for profits to soar -- and keep that ROE percentage flying high as well.
2. PDL BioPharma (NASDAQ:PDLI)
You won't find many stocks with better numbers than PDL BioPharma. The biotech's ROE of 102% comes in just behind Medivation. PDL's trailing 12-month earnings multiple is a low 3.36. Its profit margin of nearly 67% ranks it as the second most profitable healthcare company. And the stock comes with a mouth-watering dividend yield of 9.5%.
Those impressive statistics primarily stem from three drugs -- Avastin, Herceptin and Tysabri. Marketing rights for all three are licensed out to other biotechs. Royalties from those licenses have been a cash cow for PDL for quite a while, but the good times will soon be over.
PDL's patents for the drugs and several others in a group known as the Queen et al. patents expired in 2014. The company will continue to receive revenue from the Queen et al. drugs through the first quarter of next year. But after that, the game is up.
PDL BioPharma bought the rights to several other drugs in anticipation of loss of the Queen et al. patents. However, it doesn't appear at this point that these drugs will come close to making up for the revenue to be lost soon. Expect PDL's ROE to drop significantly in 2016.
3. Gilead Sciences (NASDAQ:GILD)
The biggest biotech in terms of market cap comes in third on our list with a return on equity of 90.4%. Gilead Sciences has claimed a strong ROE for several years thanks largely to its HIV drug franchise, but 2014 served as a turning point.
Hepatitis C drug Sovaldi gained approval in late 2013 but really hit its stride last year. Sovaldi was followed by another hep C treatment, Harvoni, which won FDA approval in October 2014. These two drugs combined for over $12 billion in sales last year and turbocharged Gilead's earnings.
Gilead seems likely to retain a strong ROE for a while. Although the biotech has competition from other hepatitis C drugmakers, Sovaldi and Harvoni should continue to generate lots of revenue and earnings. Gilead can also count on sustained performance from its HIV lineup, particularly Truvada and Stribild.
Looking farther down the road, Gilead's pipeline holds the potential to produce additional winners. The biotech hopes to greatly expand its presence in additional indications, including several types of cancer.
Return on equity is useful for investors, but you can't place too much emphasis on just one financial metric. Judging strictly by ROE, for example, PDL BioPharma looks like a great stock to buy. But the numbers don't tell the full story of PDL's patent expiration problems.
That being said, a stock that can consistently show solid returns on equity is often one for investors to carefully consider. Gilead Sciences is a great example of this. The best thing for investors to do is examine why a company's ROE is strong. Great businesses tend to have great returns on equity -- and make great stocks to buy for the long run.
Keith Speights owns shares of Gilead Sciences. The Motley Fool recommends and owns shares of Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.