Valuations for biotech stocks have slumped, but could rebound.
Biotech stocks took a beating over the past 12 months, but their cheap valuations could be good entry points for investors, experts say.
The outlook for biotech stocks is positive in part because the last time the market experienced a similar drawdown was during the 2015 to 2016 time period when the decline was about 50%. In the subsequent 23 months, biotech stocks “worked back to new highs and the sector was up over 130%, Thomas Hayes, chairman of Great Hill Capital in New York, told TheStreet.
Biotechs have been in a slump and have corrected over 50% since February 2021, but the weakness in the sector could emerge as steep discounts since valuations could turn around. Some metrics estimate it can skyrocket from 24% to 155%, according to this recent analysis from Bank of America.
“I don’t give advice, but I can say we have been aggressively adding a basket of the biotech sector in recent weeks on weakness,” Hayes said. “It is now one of our two largest positions in the portfolio.”
The quantitative data demonstrates that “it is undeniable there is a bargain to be had or a ‘pony in the pile’ so to speak,” Hayes said. “Everyone knows wealth is created by buying low and selling high, but when opportunity presents itself, there is always a reason not to step in. I like to say ‘Wall Street is the only market in the world where when they hold a clearance sale, no one shows up!’ Biotech is the embodiment of this maxim.”
Lowest Price/Sales Ratio in Over a Decade
This quantitative study of where biotech stocks are trading as a group with data going back to 1986 implies the sector should appreciate 24% to get back to the average price to book multiple, by 155% to get back to average price to operating cash flow multiple and 112% to get back to average forward price-to-earnings multiple, he said.
“For my money, cash flow is the most important metric as that is the means a company has to return capital back to shareholders in the form of buybacks, dividends or accretive acquisitions,” Hayes said.
One critical factor is that as multiples “overshoot to the extreme on the downside, they also tend to overshoot in the euphoria on the upside once they recover,” he said. “In other words, they don’t return to their average multiple and stop. They will overshoot beyond that before settling out.”
Biotechs are currently trading at its lowest price/sales ratio in over a decade.
“With Omicron winding down, just as people are going back to the office, they are also starting to go back to the doctor for checkups, screenings and treatments,” Hayes said. “This fact, along with drug sales reps getting off Zoom and on the road will lead to a significant uptick in scripts/demand.”
The S&P 500 biotech has risen only 8.5% in the past 52 weeks compared with a gain of 14.3% for the S&P 500, Sam Stovall, chief investment strategist at CFRA, a New York-based investment research company, told TheStreet.
Biotechs have been under performing essentially since late 2015 based on the rolling 12-month relative strength chart for the S&P 500 biotech group compared to the S&P 500, notwithstanding a short-term outperformance in 2020, he said. The last time biotech rallied was from December 2011 through December 2013, in which the S&P 500 rose 47% while the biotechs surged 193%.
