Biotech's Best And Worst | April 14, 2008 | By James Brumley - Investopedia Advisor - Sent Using Google Toolbar

Biotech's Best And Worst  |  April 14, 2008  | By James Brumley - Investopedia Advisor

Biotech's Best And Worst

April 14, 2008  | By James Brumley

On Friday I made a point about how all the major healthcare plan providers looked about the same: reasonable valuations, but frighteningly thin margins. With little room for error and growing government cutbacks, the prognosis was grim. Just to reassure myself that not all health-related companies were "a dime a dozen" I checked out the biotech industry looking for the same uniformity. Fortunately, I didn't find it.

Instead, I was pleased to find some outstanding biotech companies, that could still garner investor interest, as well as some companies that surprised me. I think both groups deserve a closer look today. I believe one is generally overvalued, and the other I believe is generally undervalued.

The Good
Medicis Pharmaceutical (NYSE:MRX): Medicis shares have lost more than one-third of their $33 value in the last 12 months, despite February's reporting of a 54% increase in fourth-quarter profits. Had the company given us a 2008 forecast above and beyond analyst's expectation, I may not even bother paying attention. However, its 2008 outlook was actually below analyst expectations, a bold move from a company with a sinking stock. And, it doesn't change the fact that the company is profitable as well as low-priced; profit margins over the last twelve months are 16% and the price-to-earnings ratio (P/E ratio) is about 17.

ViroPharma (Nasdaq:VPHM): A P/E ratio of almost 8 and profit margins consistently around 47%? Yes, there's a slowdown in sales of Vancocin. However, slower sales are still sales, and ViroPharma is still ringing the register quite well.

Amgen (Nasdaq:AMGN): You don't have to look too hard for reasons not to like Amgen. The FDA delayed its decision on Amgen's clotting-drug Romiplostim, the anemia drug Mircera is still part of a legal battle, and those are just a few of their headaches. Nevertheless, I'm still into a company that can sustain a top and bottom line even with all those issues. The P/E level is 15. (For more on the importance of the P/E Ratio to stock analysis, check out Investment Valuation Ratios: Price/Earnings Ratio.)

The Bad
 (Nasdaq:GENZ): It's actually not a bad company. I just can' t quite justify a stock valuation of 42-times earnings. The pipeline looks good. Genzyme has a pediatric leukemia drug called Clolar in the works, and an oral Gaucher's disease treatment also in development. Plus, Genzyme may resolve the manufacturing issues regarding its enzyme replacement treatment Myozyme. But, I can't help but wonder if the pipeline - none of which bears revenue - is inflating the stock price more than results.

Celgene (Nasdaq:CELG): When I saw the P/E ratio was 117, I thought it was a typo. It wasn't a typo though - nor was it a fluke. The stock's been a winner for year, but I don't think it's ever been justified by the company's results. Even the FDA's designation of Celgene's lung cancer drug Amrubicin as an "orphan drug" can't single-handedly bring the company's bottom line up to speed with the stock's price. Orphan drugs are treatments for rare diseases. This research receives tax breaks, and the drugs get extended patent protection.

Qiagen NV (Nasdaq:QGEN): Though not as inflated as Celgene, I can't get my hands around the idea of this company's stock trading at 73 times earnings. It's a biotech diagnostic supply company, that has somehow managed to grow the top line over the last three years but still shrink the bottom line (with or without Q4's charges).

The Bottom Line

You may be thinking the undervalued stocks have low P/E levels solely because those stocks have been getting beaten up. The opposite rings true for the overvalued stocks - they've been rallying despite being expensive. Why jump on a sinking ship, and why get off a floating one? The other dimension here is profits. Remember those? My "best" companies also have wide and reliable margins while my "worst" companies have oddly thin profit margins. That's got nothing to do with the stocks prices.

The bigger message, though, is to recognize that nothing lasts forever. In much the same way the market's sectors rotate their leadership role with one another, so too do the stocks within an industry. Eventually, companies with strong profits - rather than stories of potential - will push their way to the top of the heap.

To learn more about the cyclical nature of biotech stocks, read The Ups And Downs Of Biotechnology and Chasing Down Biotech Zombie Stocks.

By James Brumley

James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.

At the time of writing, James Brumley did not own shares in any of the companies mentioned in this article.