Here we have an interesting matchup between two of The Motley Fool's most dedicated biotech-watchers -- myself and Charly Travers. Both of us follow biotechs, like biotechs, and own biotechs. But in this case, it looks like we're gonna have a failure to communicate regarding Protein Design Labs
Now, I'm sure my esteemed colleague will use words like "hope," "potential," and maybe even "blockbuster." That's the nature of biotech; the industry is built on selling hope. In truth, nobody really knows which drugs will succeed or fail. That's why companies have to conduct multiple trials on ever-increasing numbers of patients.
Hope is all well and good. But what's the right price for it?
Beware the shake, rattle, and roll
Saying that the biotech sector is volatile is a bit like saying that climbing Mount Everest takes a touch of effort. Take a look at a chart of iShares Nasdaq Biotechnology
That's just the industry risk; biotech stocks like Protein Design Labs also carry a considerable amount of what's called "event risk." A single piece of bad news can really pound a biotech stock. PDL has a fairly diverse pipeline and a good ongoing royalty stream, but what happens if one of its phase 2 trials fails?
Yeah, believe it or not, valuation actually does matter, even in the world of biotech. While revenue and profit predictions for biotech stocks are certainly more ephemeral than for other industries, buying with a margin of safety has helped me in the past.
My first line of valuation is a model based on the company's pipeline and existing business (if any). Analyzing this company, I come up with figures like $13 per share for the antibody business, and about $5 per share each for the pipeline and ESP Pharma business. Offset that with $5 per share of debt, and you get about $18/share.
My second wave of attack is the price-to-book ratio. No, really, I'm serious. I know it sounds bizarre that a crusty old Graham & Dodd metric like price-to-book could have anything to do with picking biotechs, but I've found that it works well for me.
In particular, I've found that paying less than three times book value for a biotech with a quality pipeline usually works out pretty well. Protein Design's present valuation of 4.6 times book puts it in my "no thanks, I'm just browsing" category -- not overvalued yet, but not really interesting for purchase, either.
Patents are valuable in the world of biotech and pharmaceuticals, but there's also fierce competition. Look no further than the triumvirate of erectile dysfunction drugs or the host of depression drugs and you'll see that, in this case, imitation is the sincerest form of battery.
Now, I'll grant that Protein Design Labs is targeting high-potential markets like asthma, congestive heart failure, and cancer. So is nearly every other biotech, it seems. Will Protein Design's candidates be strong enough to really stand out in a competitive field? Frankly, I'd like to see a bit more pioneering work from the company -- exploring more treatments for conditions with few (if any) viable alternatives.
There is absolutely a place for stocks like Protein Design Labs in most portfolios. When they hit, biotechs hit big. Even an occasional winner can more than pay for many losers. I actually like this company; I just don't happen to like the present stock price.
I've done well for myself, picking winners like ICOS
Protein Design Labs has beaten the market a few times over since being recommended in the Motley Fool Rule Breakers newsletter service. The average pick has nearly tripled the S&P 500's return. You can take us up on a free 30-day trial to see what all the fuss is about.
Keep up with every step of the duel. Read Charly Travers' initial bullish commentary, then head on to Charly's rebuttal and Stephen's last word. Once you're done, don't forget to cast your vote for this week's winner.
Fool contributor Stephen Simpson has no present financial interest in any stocks mentioned.