This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Biotech Not Cratering, Just Deflating

To see where the biotech sector is headed tomorrow, it might be helpful for investors to look back, and more importantly, forget about, the recent past.

The outlook from this perspective is sobering: Biotech valuations are only now beginning to trade below historical levels, despite what seems like a calamitous drop in stock prices. Right, you guessed it: Biotechs could still head lower.

The Amex Biotechnology Index closed Wednesday at 309.32, quite an accomplishment considering that a profit warning from drug-equipment maker Qiagen (QGENF) and a Genentech (DNA) downgrade sank the index to as low as 290.67 earlier in the day. The drop below the 300 level was noteworthy as a psychological, if not technical, measure of just how badly the sector is performing this year -- down 46% for the year.

But don't call a bottom yet. The BTK has retrenched back to December 1999 levels, which is an interesting time frame because, as longtime biotech investors will recall, the sector, at this time, was in the midst of a bubble, inflated by the hype over genomics and, of course, the general mania in technology-related stocks. It may seem like a distant memory, but towards the end of 2000, the BTK actually approached 800. And as one reader points out, enthusiasm was so great that one analyst at Credit Suisse First Boston, in September 2000, was actually talking up the likelihood of BTK 1000.

Forget About It

We bring this up to suggest that biotech investors might want to simply erase the roughly two-year biotech bubble from their memory, in order to better evaluate current valuations.

That's what Lazard Freres biotech analyst Joel Sendek did recently, and it suggested to him that biotech valuations are only now beginning to trade below historical levels, despite the aforementioned steep slide in stock prices since late last year.

To determine historical biotech valuations, Sendek decided to remove the 21-month bubble period from June 1999 to March 2001 from his calculations. He came up with a historic, average P/E for the biotech sector of 40 times earnings. The historic average P/E-to-growth multiple is 1.6.

At the end of June, when Sendek issued his report, the average P/E for a basket of eight profitable biotech firms was 35, while the PEG multiple was 1.47.

"Our analysis reveals that biotech valuations have only recently begun to trade within historical long-term ranges -- for the first time since" the first quarter of 1999, he writes. "Given what we believe to be weak near-term fundamentals in the biotech industry, we see further downside potential in valuations to the lower end of their historical ranges, representing 10%-20% downside from current levels, before any major rebound is likely."

The BTK was trading around 340 when Sendek issued his report on June 26. By his reckoning, the index will fall to the 275-310 range before any rally occurs.

As a result of his revised valuation analysis, Sendek lowered his Genentech rating to hold from buy. He reiterated his hold and buy ratings on Amgen (AMGN) and Idec Pharmaceuticals (IDPH), respectively, but he lowered price targets on each. Lazard doesn't have an existing banking relationship with any of the above-mentioned companies.

Take Genentech -- Please

Genentech offers a good example of just how fragile biotech valuations are these days. The stock fell 5% to $28.70 Wednesday after Deutsche Bank Securities biotech analyst Dennis Harp used the day before the July 4th holiday to downgrade the company to market perform (read: hold) from buy. The main reason? Valuation. By Harp's calculation, Genentech was trading at a 2003 P/E-to-growth multiple of 1.5, a significant premium to the other profitable biotechs, which as a group, trade at a 2003 P/E-to-growth multiple of 0.8.

Harp also believes that Genentech will come up short when it reports results later this summer from a Phase III trial of its experimental cancer drug, Avastin. His firm doesn't have a banking relationship with Genentech.

Earnings season is typically a good time for biotech investors, but Biogen (BGEN) and Genzyme General (GENZ) have already warned, which suggests that second-quarter results will not be bullish enough to provide any meaningful lift for the sector. So while the BTK's ability to stay north of the 300 level Wednesday should be taken as a victory, it may only really be a temporary reprieve.

Select the service that is right for you!

Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 17,613.06 +256.19 1.48%
S&P 500 2,038.30 +25.41 1.26%
NASDAQ 4,707.1580 +62.8460 1.35%

Brokerage Partners

Rates from

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs