Biotech Valuations Are Low Not Stretched. Here's Why.

NEW YORK (TheStreet) -- Federal Reserve Chairwoman Janet Yellen's recent comments calling biotech stock valuations stretched had an immediate, downward effect on stock prices and re-invigorated the long-simmering debate on whether or not the sector was in the midst of a bubble. Perhaps the most compelling valuation case in the biotech sector are the large-cap stocks with relatively low price-to-earnings (P/E) multiples and significant growth potential. Biogen Idec (BIIB), Gilead Sciences (GILD), and Celgene (CELG) all reported second-quarter earnings last week, sending a strong signal on both the fundamentals of the sector and how these are perceived in the market.

Biogen has the richest valuations of the three with a forward P/E of 21.6, not significantly higher than the S&P forward P/E of 16.5. Biogen's second-quarter earnings and revenue beat Wall Street expectations. The company also raised guidance for the rest of 2014. This is the result you'd expect from a company with a premium valuation. Biogen delivered what you would expect, if not more given the reaction in the stock price.

Gilead went into its earnings announcement with massive expectations for Sovaldi sales (whisper numbers of $3.5B plus or minus half a billion) but also with a forward P/E of only 10.7. Investors expects a lot from Gilead in the near term (strong Sovaldi sales) but are more concerned about long-tern growth (lower forward P/E) due to the risks hepatitis C revenue tails off with competition looming. 

Gilead reported second-quarter Sovaldi sales of $3.5 billion, in line with buyside whisper estimates, and provided 2014 product sales guidance that included full-year Sovaldi sales for the first time. If you use the low end of the current guidance, the 2014 P/E of Gilead is only 12.7. That is lower than the forward P/E of the broader market. Gilead sold off immediately following last week's earnings announcement but recovered and the stock is now moderately higher. In some ways, it seems there was a battle between those slightly disappointed that Sovaldi did not crush the whisper number versus those who see the long term value in the stock.

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