Are ALL Biotech Stocks in a Bubble? It’s something I’ve got to ask myself as the second half of 2014 approaches. At this point in time there’s a lot of talk about biotech bubbles.
And to be honest…
I tend to agree! I think biotech stocks have had a wild run over the last couple of years. And at this point, a lot of them are laughably overvalued. But don’t take my word for it.
Here’s an updated monthly chart of IBB, (a publicly traded ETF for biotech stocks). See for yourself:
By the way, you can read the IBB component companies too. But the main thing to consider is that biotechs have gone on an epic run over the last 2 years. And now they’re coming back down to earth.
But are ALL of these biotech stocks still overvalued?
Just take another look at the IBB monthly chart above.
Do you see what I’m getting at? While the biotech stocks have clearly had a huge run going into 2014, they were also stagnant for the 10 years prior. If you look carefully you can see that heading into 2013, biotech stocks as an index were trading at the same levels they were in 2002!
So are ALL biotech stocks really in a bubble?
Biotech Stocks in 2014: Bubble or Buying Opportunity?
The simple truth is that the broad panic selling of the biotech index will cause fear to spread in people who are over-exposed in biotech stocks. That means they will probably consider selling their biotech stocks too (at least to lock in some profits).
Do you see where I’m going with this?
The selling in biotech stocks starts to bring the IBB down almost as fast as it went up! And this big time price volatility is sure to leave some investors running scared.
But blind biotech selling also leads to inefficiencies in the stock market!
Think about it: Not all biotech stocks are the same. They have different sales growth, EPS and free cash flow rates. But the market doesn’t seem to care.
Right now, the liquidation is hitting the whole biotech sector. And if that goes on long enough, certain biotech stocks begin to look really under-valued.
Of course, the trick is finding the right ones.
Biotech Buying Opportunities in 2014:
There are couple of ways to hunt for biotech buying opportunities in 2014, if that’s your inclination. And naturally…
One of my favorite ways to find stock ideas is using stock screeners. For this biotech stock research I would probably use a variation of the best value stock screens in 2014. In this case I think consistent free cash flow, sales growth and strong growth estimates are necessary to ensure you have a sufficient margin of safety. Make sense?
Another way to whittle down your list would be to use an intra-industry analysis stock screen focused exclusively on the biotechnology sector. You can set this up for free in Finviz and really drill down on the different biotech stocks. By looking for the most under-valued stocks (from a current and future sales, EPS and/or free cash flow perspective) you can really start to identify biotechnology buying opportunities.
One idea that popped out on an initial screen was Jazz Pharmaceuticals (NASDAQ:JAZZ). I don’t own any JAZZ and I probably won’t end up buying any.
But it’s a perfect example…
JAZZ meandered from 2007-2011 before going on an epic run higher from $10 to almost $200 over the next three years. JAZZ has now pulled back to $137 and still threatening to sink lower. So while the fundamentals may not justify a $200 price tag, they might justify a $160 price tag.
But is it worth catching falling knives?
Valuing biotechnology companies comes with a unique set of challenges owing to the complex regulatory framework, the various reimbursement programs and the intense intellectual property competition. If you’re not familiar with the space you’re going to need to get up to speed… (or maybe you have a friend who’s a doctor).
Another Word of Warning About Biotech Bubbles:
At this point, all of this is just an academic exercise about where biotech bubbles stand in the current market environment. Putting money to work is much riskier of an idea. And I need to stress to you that just as markets were irrational on the upside, there is a very good chance they could be exuberant to the downside too.
If you try to bottom pick biotech stocks you’re probably in for a bit of pain. There’s a lot of indecision in the market about biotech stocks right now. So tread lightly.
You’re going to need to be patient. And pick your battles carefully. But I’m willing to bet…
If you can put in the work, and your time frame is long enough, there could be a very profitable buying opportunity right around the corner in the world of biotech stocks. I actually have my eye on a few. Additionally…
One strategy might be to buy puts against the most overvalued biotech stocks and build equity exposure in under-valued biotech stocks only when they start to move up (along with broad market strength). Building these positions slowly with some insurance might be the safest way to play this (note: I’m not recommending you play this one way or the other – this is just for discussion).
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