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Visualizing Biotech P/E Compression and Why It's a Buy Signal

J.P. Morgan analyst Geoff Meacham issued a cautiously optimistic note about the biotech sector this morning. While investor sentiment remains "fragile," and volatility continues to be high, Meacham believes the worst of the selling is over, based on conversations he's had with investors recently. 

Meacham on large-cap biotech stocks -- Gilead Sciences (GILD - Get Report), Alexion (ALXN - Get Report), Celgene (CELG - Get Report), Biogen Idec (BIIB - Get Report) and Amgen (AMGN - Get Report):

Since late February, the forward P/Es have compressed in biotech (see Figure 1). Indeed, the Big 4 Biotechs currently trade at a forward PE multiple of 16.6x which represents a modest premium relative to the broader market (S&P: 15.2x) despite a significantly higher earnings growth (Big 4 biotech: 31% vs. S&P: 10%). Of note, this is the lowest premium (1.3 turns) for the Big 4 relative to the S&P since early 2012. As such, with valuations nearing that of the broader market despite a differentiated and longer duration growth profile, we'd argue that biotech is much more attractive following the recent pullback.

The same in a nice chart form:

First-quarter earnings season is mostly behind us, and it wasn't all that great, with about half of the companies with products to sell missing consensus estimates. However, the first quarter is typically the toughest due to inventory fluctuations and 2014 revenue and earnings growth expectations remain quite strong at 31% and 51%, respectively.

Adam Feuerstein writes regularly for TheStreet. In keeping with company editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet. He also doesn't invest in hedge funds or other private investment partnerships. Feuerstein appreciates your feedback; click here to send him an email.


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