After the Run-Up and Sell-Off, Are Biotechs in a Bubble Against Big Pharma Valuations?

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Biotech stocks come and go as far as the flavor of the day for investors. While many of these companies are risky, and while many are too risky for many investors, what investors need to know is that as an asset class or sector these represent the new drug giants of tomorrow. The question that we have is whether the valuations are getting stretched too far now that major biotech stocks have risen and risen. The good news is that there are at least some ETFs that give exposure here, in order to avoid the inherent risks of just one company.

Before calling it a bubble, there are many things to consider. While there are some major ETFs in the sector, we have noted previously how these biotech ETFs are often misrepresented by their name, given the weightings and stocks they hold. Another issue is culling out the risky one-candidate companies from the established biotech leaders. A long-term comparison also can be made to drug giants for relative valuation and for dividends.

As far as why we are asking if a bubble is forming here, it is not just because these stocks have performed well. The four major U.S. biotech players are Amgen Inc. (NASDAQ: AMGN), Biogen Idec Inc. (NASDAQ: BIIB), Celgene Corp. (NASDAQ: CELG) and Gilead Sciences Inc. (NASDAQ: GILD). All four companies hit new all-time highs this last week.

24.7 Wall St. is taking a look at each for valuation metrics by market capitalization, forward earnings multiples, sales and earnings growth expected, and paring up the current stock price against the Thomson Reuters consensus price targets from Wall Street analysts.

Before we get into biotech, Pfizer Inc. (NYSE: PFE) and Merck & Co. (NYSE: MRK) need to be evaluated. Both drug giants were trading very close to multiyear highs going into earnings this week. Somehow the market did not anticipate that both companies were going to offer muted guidance ahead. Merck is now down almost $4 from its 52-week high of $48.78, and Pfizer is down more than $2 from its 52-week high of $31.15. Both stocks trade at 12 or 13 times the projected 2013 earnings estimates from Thomson Reuters.

What sets Big Pharma stocks apart from biotech stocks is that there is just no revenue growth expected this year, or next even, if the so-called patent cliff woes are mostly behind these companies. Pfizer’s common stock dividend yield is 3.2%, versus 3.6% for Merck. Only one of the major biotechs (Amgen) pays a dividend as the sector is still tracking for growth.

Amgen Inc. (NASDAQ: AMGN) took a beating after its earnings report last week. Even after being added to the Conviction Buy List at Goldman Sachs, the biotech giant is up 2% at $106.25 after a recent all-time high of $114.95. The firm’s price target is $130 now, with a consensus target from analysts down at $111.36 and a street-high target of $133 for Amgen. It took a sell-off for this stock to get back under the consensus price target. Amgen shares are still up 24% so far in 2013 after the recent sell-off. The good news is that Amgen trades at about 14.6 times expected earnings this year, but the bad news is that sales growth is projected to be less than 5% for this year and next. Amgen is not really expensive for a biotech stock, but it is missing that monster growth. Amgen also acts like a new Big Pharma stock now that its dividend yield is 1.8%.

Biogen Idec Inc. (NASDAQ: BIIB) is now down $10 from its recent all-time high of $226.18. It was removed from Goldman Sachs’ Conviction Buy List, but at $216.25 its consensus price target is all the way down at $202.56. Biogen’s multiple sclerosis franchise is now approaching a total domination in the field. It pays no dividend but is expected to post 16% to 17% sales growth in both 2013 and 2014. The problem that investors may face going forward is that valuation is stretched at more than 27 times the consensus 2013 earnings estimate, since this stock has risen a whopping 48% so far in 2013.

Celgene Corp. (NASDAQ: CELG) is down just over $10 per share from its recent all-time high of $128.52. The consensus price target of $124.69 is also under the most recent high, while the street-high price target is up at $143.00. What Celgene has going for it is that some market pundits expect its earnings to double by 2015 to 2016. Sales are expected to rise more than 10% for at least the next two or three years, as well. That being said, Celgene trades at about 21 times expected 2013 earnings estimates, now that shares have risen a whopping 50% so far in 2013.

Gilead Sciences Inc. (NASDAQ: GILD) is down about $5 from its recent all-time high of $55.16. Gilead trades at about 25-times expected 2013 earnings, and its shares are up by 37% so far in 2013. The consensus price target is above the prior high at $58.20, and the highest target price is around $70 for the HIV drug leader. Sales continue to grow in the double-digits and are expected to maintain that path for at least the next two years.

Now before you run off scratching your head, there are the market capitalization figures to consider, versus $208 billion for Pfizer and $138 billion for Merck. Amgen is king at about $80 billion as of now, and it seems to be the first biotech that could ultimately reach the mega-cap class at $100 billion. The problem with thinking Amgen will be first is that analysts project more upside and growth at Gilead, and its market cap is almost $77 billion. Biogen Idec is worth more than $51 billion and Celgene is worth about $49 billion.

Biotech stocks have performed incredibly well so far in 2013. For value-oriented investors, these still need to soften up in price. For investors who chase growth at any price, there is still some perceived upside. The good news is that biotechs have pulled back and now Big Pharma stocks have all pulled back. The bad news is that if the market does not keep rising, it is very likely that investors will look for more patient entry points before chasing these high gains and valuations in biotech.

For those looking for undervalue growth with more risk, a firm called PropThink has just issued a list of biotech stocks that it feels are not represented with proper valuations (yet) by the market.

One more issue we noted in much more detail in our ETF Folly for Biotech ETFs is that the exchange traded fund universe is very underrepresented in this sector, regardless of valuation analysis. The top ETFs here are the iShares Nasdaq Biotechnology (NASDAQ: IBB), SPDR S&P Biotech (NYSEMKT: XBI), First Trust NYSE Arca Biotech Index (NYSEMKT: FBT) and the Market Vectors Biotech ETF (NYSEMKT: BBH). Note that the combined market capitalizations are not quite 2% of the combined market valuations of just the top four biotech stocks.

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