Looking ahead into 2021, the biotech sector is attractive from many perspectives. Valuations are quite reasonable and earnings have steadily increased. The leading stocks in the sector have…
high-margins and above-average revenue growth. Finally, the total addressable market for effective treatments continues to expand.
Another catalyst for the sector is that due to the coronavirus, many countries are increasing spending on public health and upgrading their health infrastructure. Private-public partnerships like “Operation Warp Speed” seem to be working and have created a framework to incentivize and support companies who are developing therapies that could yield public health benefits.
Valuations
Over the last five years, biotech valuations have gone from frothy to being cheaper than the S&P 500. In mid-2015, the IBB’s price to earnings ratio was around 90 at its peak. Today, it’s 20.2.
Since prices have been essentially flat, multiples compressed as earnings grew by 4.5 times over this period.
The 14-year, monthly chart above shows that from 2009 to 2015, the iShares Nasdaq Biotechnology ETF (IBB) gained 594%, which handily outperformed the S&P 500’s 220% gain over the same period.
At their peak in 2015, biotechs were getting frothy with elevated levels of call buying and huge gains in many speculative names. Valuations were also hitting extreme levels that led many prudent investors to steer clear from the sector.
Sometimes, these excesses are cleared out with a dramatic move lower that wipes out call-buyers and overleveraged traders. In biotech’s case, the excesses were cleared out with a multiyear period of range-bound trading.
Now, this quiet period looks to be ending. The bull market looks ready to resume as prices are consolidating near all-time highs, while fundamentals are much stronger than a few years ago.
Growth Potential
While IBB is cheaper than the S&P 500, it’s projected to increase revenues between 7 and 12% over the next five years, while the S&P 500’s revenue growth is projected to be in the low single digits.
Additionally, due to the…
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