With a little thing called an election taking place tomorrow, and both of the candidates having made some serious shots across the bow against drug price increases, biotech stocks have been getting hammered this year. IBB, which is the iShares biotech ETF, has dropped 24% in 2016 compared to a 6% rise in the S&P 500.
While I generally recommend a passive, diversified portfolio that keeps costs low and takes advantage of dollar cost averaging, rebalancing and tax-loss harvesting, I occasionally invest in individual stocks, and right now, there are some interesting opportunities in biotech compared to a U.S. stock market that otherwise appears to be overvalued.
I will try to slice this multiple ways because there are so many different ways to value stocks. Out of about 200 stocks on my follow list, biotech stocks are 5 of the top 10 based on the lowest price to fair value ratio according to Morningstar. Of those top 5, all are trading with a dividend yield above each their respective 5 year average dividend, and with price/book and price/cash flow ratios below their respective 5 year averages. To many, an above average dividend yield and a below average price/book and price/cash flow is a great sign of an undervalued company.
Comparing these stocks to the S&P 500 reveals that their forward price/earnings ratio averages 11 as opposed to 18.7 for the S&P 500. Those same stocks have an average EV/EBITDA of 9 compared to about 14 for U.S. stocks as a whole. Now, in addition to be undervalued compared to their own history, this group of stock is also undervalued compared to the U.S. market, even by looking at different valuation measures.
Of course, these stocks (GILD, RHHBY, BAYRY, AMGN and SNY in case you were wondering) aren’t trading at lower prices for no reason. Rather, there are industry related concerns as mentioned above and each company has its own problems. That’s why I read through quarterly reports and conference call transcripts as well as focus on the company’s cash flow and plans to return cash to its shareholders through dividends and stock repurchases. I can’t predict what will happen to a company’s stock price, and I can only conservatively estimate what will happen to a company’s cash flow. But if my conservative estimates about cash flow payments to shareholders indicate that a company’s price is a good deal, and that is consistent with the company’s valuation on a relative and comparative basis as described above, then I will consider pulling the trigger.
Disclosure: Christy or I own GILD, SNY and AMGN. I do not intend to make any trades of any of the above mentioned securities in the next 48 hours.