Even after the first correction in four years, biotech stocks are absolutely crushing the S&P 500 over the trailing-five-year period. In fact, the SPDR S&P Biotech ETF has more than quadrupled the performance of the broader-based S&P 500 over that time span (297% versus 72%).
There are a couple of reasons investors favor biotech stocks in a rising or recovering market. Primarily, it's because biotech stocks, more than any other sector of the market, are valued based less on fundamentals and more on their long-term sales potential and investors' emotions. Nearly nine out of 10 biotech companies are losing money, therefore traditional fundamental valuation metrics wouldn't do investors much good when it comes to valuing these companies. So when investors are willing to take on higher levels of risk in a rising market, biotech stocks tend to shine brighter than most other sectors.
However, biotech stocks also offer superior growth potential -- if they manage to get their experimental drugs approved by the Food and Drug Administration and can keep their costs under control.
The fastest-growing biotech stocks
Which biotech stocks are growing the fastest? That really depends on the criteria you set.
In my quest for the fastest-growing biotech stocks, I weeded out companies that were expected to be losing money for the foreseeable future (through 2018), as well as small biotech stocks with market valuations below $500 million. What remained was a handful of biotech stocks expected to grow their profits over the coming five-year period by an average of at least 45% per year.
Pacira Pharmaceuticals (NASDAQ:PCRX): 77% annualized EPS growth over the next five years
Far from a household name, Pacira Pharmaceuticals is projected to be the fastest-growing biotech stock, with a forecast EPS growth rate of 77% over the next five years. Pacira's EPS is expected to increase from the $0.37 per share it reported in 2014 to $4.35 per share by 2018.
Pacira's product portfolio is extremely reliant on one drug: Exparel. Exparel is a non-opioid injection administered to a surgical site that's designed to provide post-surgical pain relief for patients. In Pacira's most recent quarter, Exparel accounted for 96% of Pacira's total revenue, or $57 million of its $59.1 million. The $57 million in product revenue represents a 27% increase over the $44.9 million in sales Exparel realized in Q2 2014. Once Pacira has built up Exparel's brand image, it should be able to dramatically cut its marketing expenses and watch its margins soar.
When it comes to Pacira, investors should be aware of two primary concerns: Exparel sales are slowing on a year-over-year basis -- which, according to management, should only be temporary -- and the company relies heavily on just one drug. Even if Exparel's future looks bright -- varied Wall Street estimates have suggested that Exparel could generate anywhere from $400 million to $1 billion in peak annual sales -- relying on a single drug can be troublesome if a new competitor enters the space, if insurers or pharmacy-benefit managers push the product off approved reimbursement lists, or if safety becomes a concern. Right now, none of these looks like an issue for Pacira, but the company's overwhelming reliance on Exparel makes it an investment opportunity for seasoned biotech investors with a high tolerance for risk.
Supernus Pharmaceuticals (NASDAQ:SUPN): 70% annualized EPS growth over the next five years
Following closely behind Pacira as one of the fastest-growing biotech stocks is Supernus Pharamceuticals. Supernus, which focuses on developing therapies to treat central nervous system disorders, is expected by Wall Street to grow its EPS from a reported $0.32 in 2014 to $2.06 by 2018.
Unlike Pacira, which is reliant on one drug, Supernus has benefited from the sales growth of two FDA-approved products -- Oxtellar XR and Trokendi XR -- for the treatment of epilepsy.
Year-over-year sales of Oxtellar grew by 60% in the second quarter to $8 million from $5 million, while Trokendi sales improved to $26.3 million. Excluding the change Supernus made in the way it accounts for revenue in the year-ago quarter, Trokendi sales grew by a whopping 148% year over year. Comparatively, Supernus' research and development expenses totaled a mere $6.9 million during the quarter, and gross margin nearly hit 95%.
Supernus also has an intriguing pipeline product, SPN-810, a treatment for impulsive aggression associated with attention deficit hyperactivity disorder. Phase 3 enrollment for SPN-810 is expected to commence within the next couple of months. In its reported phase 2b study, SPN-810 led to a statistically significant remission in the R-MOAS score (a scale that measures aggression) of 51.9% in the SPN-812 cohort compared to 40% for the placebo cohort.
The risk with Supernus? Primarily, it's the focus on psychiatry products, which have a very high clinical failure rate. Clinical programs focused on depression, ADHD-associated aggression, and even ADHD itself could offer promise if they're successful, considering how little new competition is on the market, but far more companies will fail in these indications than succeed. This simply means that investors would be wise to base the bulk of Supernus' future valuation on its epilepsy portfolio and use its experimental psychiatry portfolio as icing on the cake if it succeeds.
Ligand Pharmaceuticals (NASDAQ:LGND): 45% annualized EPS growth over the next five years
Lastly, you'll find Ligand Pharmaceuticals among the fastest-growing biotech stocks with a projected annualized EPS growth rate of 45% over the coming five years. Wall Street believes Ligand can grow its EPS from a reported $1.52 in 2014 to well over $6 per share in 2018.
Ligand may not be able to match the exceptional growth rates offered by Pacira or Supernus, but it could be the most attractive of the three considering its diverse product portfolio:
Ligand's bread and butter includes multiple myeloma drug Kyprolis, for which it receives tiered royalties that increase from 1.5% up to $250 million in annual sales to 3% for anything above $750 million. Following its approval as a second-line treatment for multiple myeloma, Ligand should be set for a 3% minimum royalty within the next 12 months, by my best estimate. Ligand also receives royalties for Promacta, a medicine designed to increase the number of platelets in the blood.
What makes Ligand particularly intriguing is its Captisol technology, which improves the solubility and stability of active pharmaceutical ingredients. Ligand currently has more than 120 partnerships where its Captisol formulation technology is being utilized, meaning it has a boatload of royalty opportunities that could last for a long time.
The biggest risk I see with Ligand is the potential for sales lumpiness. For example, modeling revenue projections for Ligand is practically impossible, given its 120 partnerships and the royalties streaming in from each one. Looking at Ligand's sales over the course of a year, it seems likely that investors will see growth, but on a quarter-to-quarter basis Ligand's sales could be all over the place.
Of the three fastest-growing biotech stocks, this is the one I'd suggest investors most closely look into for their own portfolio.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool has no position in any of the stocks mentioned. 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.