Why Are Biotech Stocks Surging and How Are They Valued?

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The coronavirus pandemic has powered biotech stocks in 2020.

But beyond the fact that a vaccine would mean huge profit growth for these companies, how do we actually forecast profits, what’s been driving the recent volatility of biotech stocks, and what can you expect from the group going forward?

Let’s dive in.

Valuing a biotech company means zeroing in on the value each drug can bring the company and then summing up the value of all of those drugs.

But figuring out the value of a single drug is complicated, and depends on hard-to-find answers to a number of questions.

How many people might need the drug in each year of the valuation? How much market share can each drug maker take? What can we reasonably expect the price per dose to be? Answers to these give us revenue attributable to the drug over the years the drug is in use.

Then, what are the costs attributable to each drug? How much money in operating expenses is needed? What about capital expenditures? So how much free cash flow is attributable to each drug?

Next, you need to discount the free cash flow by the likelihood the drug is approved because we don’t know the drug will really be approved. For example. in phase one there may be a 10% probability of success. So we would reduce the free cash flow value by 90%. As the drug moves closer to approval, we will have a much lower discount rate. And then of course, we have to discount by the company’s cost of capital.

Then, we add up the value of discounted cash flow of all drugs the company is planning on making and selling.

Recently, biotech heavy weights like Gilead Sciences  (GILD) - Get Report and Moderna  (MRNA) - Get Report have seen large swings in their share prices. Moderna and Gilead are up 210% and 12% year-to-date, respectively. As the process has moved along for both of these companies to get their COVID-19 vaccines to market, their share prices have skyrocketed, followed by meaningful drawdowns as uncertainty over the likelihood of approval has entered the fray.

To see what the outlook is and risk-reward scenario for these stocks, watch the quick video above. 

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