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Biotech Bloodbath Set To Continue On Wall Street

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The biotech sector has paid investors handsomely over the past several years, but recent negative headlines, unrealized innovations and sharp stock declines suggest that the tide is turning for the worse. Over the past five years, investors bid up shares as increased drug pricing and a relaxed regulatory environment lead to strong earnings growth for many biotech firms. But what should we expect in this sector going forward?

A chart of the Ishares Biotech ETF (NASDAQ: IBB) over the past 5 years shows gains of almost 150% since 2011. In the same time span, the S&P 500 increased just 54%.

IBB Chart

IBB data by YCharts

Improved sentiment towards the biotech sector and the healthcare sector as a whole was evident in the private markets as well. Theranos, the company that promised to revolutionize blood testing by using only a pinprick, soared to a private market valuation of $9 Billion. To put that in perspective, Labcorp and Quest Diagnostics, two of the largest blood testing companies in the United States, have a market capitalization of $13 Billion and $11 Billion respectively. Theranos has been marred by reports of faulty manufacturing processes and claims that it mislead investors. Although Elizabeth Holmes, CEO of Theranos, has promised to solve the problems, investors are likely looking at an investment worth a small fraction of its peak valuation.

One can’t help but wonder if a similar fate is inevitable for biotech investors. Biotech has always been an appealing investment because of the promise of revolutionary drugs that will transform the marketplace. To its credit, the biotech industry has introduced many life saving drugs over the years, and will likely introduce many new revolutionary drugs in the future. But the issue for investors considering buying biotech shares is what prices those drugs will command. And this point, to the chagrin of biotech investors, has become a central issue in this election year. Hillary Clinton has been outspoken about “outrageous” drug prices. Her tweet in September about price gouging by Turing Pharmaceuticals, formerly lead by founder and ex-CEO Martin Shkreli, sent biotech shares tumbling. The IBB is down about 25% since that tweet. In late March a dozen congressional Democrats called for a hearing on the prices of a drug called Xtandi , owned by Medivation. Xtandi costs $129,000 for a course of treatment before discounts. As the election approaches, rhetoric against rising drug prices is not likely to dissipate, and may escalate to new heights.

When sectors have parabolic moves like the biotech sector has had, the losses can be equally painful to the downside. If the drug pricing issue leads to increased regulations, analysts will lower earnings estimates, and biotech firm may report lower earnings. This dynamic could lead to a seismic outflow from the sector, driving down biotech shares further in the red.

All good things come to an end. Investors have been rewarded handsomely in biotech shares over the last few years, even after accounting for this year’s losses. After many years of incredible breakthroughs and soaring profits, it is hard for analysts and investors to give up on the sector. But taking an objective view, one can’t help but wonder if the best days for biotech stocks are in the rear view mirror.

Ideal Asset Management’s Take:

Low PE ratios and expectations of continued earnings growth will undoubtedly tempt value investors into the biotech sector. We are resisting the urge to invest in the sector for the time being. Increased political rhetoric leading up the presidential election may put increased pressure on the sector. Many biotech stocks that look cheap currently are at risk of becoming a lot cheaper. If there is a flight out of the biotech sector and stocks fall dramatically from current levels, it may be worth a look, but for the time being the risks seem to outweigh the potential rewards.

 

 

Disclosure:

All of the ideas expressed in this article are the opinions of Ideal Asset Management LLC

Before trading on any of the information in this article, consider consulting your financial advisor to make it suits your financial goals

Ideal Asset Management has no positions in any biotech stocks for its clients

All investments carry the risk of loss

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