How to Value Biotech Stocks

Trying to value biotech stocks, particularly those with no products on the market, isn't easy.

Consider, for example, that in this sector, in order to achieve an earnings multiple on which to base buy and sell recommendations, forecasting models often need to be extended out four or five years.

Imagine attempting to engage in the same exercise with retailers, like Costco (COST), or tech companies, like Dell. Predicting what sales and earnings will be for this fiscal year is difficult enough without having to start worrying about 2010 or 2011.

Now add variables such as safety issues, efficacy, competition and the small matter of not knowing if a drug will even be approved and make it to market, and you can see how difficult it is to determine the proper valuation for a biotech stock, particularly one with no current earnings.

Nevertheless, investors love the sector because of the potential rewards. Those who bought Amylin Pharmaceuticals (AMLN) in June of last year have already tripled their money as diabetes drug Byetta fueled enthusiasm for the stock, and long-term holders of companies like Genentech (DNA) have indeed been nicely rewarded.

How It's Done

If you want to do your own research, the skills and time required are substantial. Simply knowing about a particular drug that will meet an unsatisfied need is not enough. For our purposes, we'll assume the company we're examining doesn't have a product on the market yet.