Take Advantage of the Slaughter in Biotech

The slide in emerging markets triggered a selloff in biotech stocks - a classic example of quality stocks getting punished for being in the wrong sector at the wrong time.

This article is published with permission from InvestmentU.com.

At the J.P. Morgan Healthcare Conference in San Francisco three weeks ago, it was all rainbows and unicorns when it came to the biotech sector.

At that point, the sector had climbed 50% over the previous year and 140% since the recent low in November 2011. Biotech was white-hot.

And then the conference ended and seemingly everyone sold all their shares. At least that’s the way it feels. The Amex Biotech Index (NYSE: BTK) fell 8% in less than two weeks. The smaller cap names got crushed.

In my Healthcare Profits Alert service, we got stopped out of two of our small cap names: Idenix Pharmaceuticals (Nasdaq: IDIX) and Dynavax Technologies (Nasdaq: DVAX), taking profits of 52% and 21%, respectively. Subscribers who bought calls in Idenix made 150% in about a month.

Because I raised the stop as the stocks climbed higher, we exited the positions with much of our gains still intact.

Panic sets in

The slide in emerging markets set off a panic in speculative assets in the United States, and biotech investors who were sitting on fat profits decided to take their ball and go home. It’s hard to blame them when they were sitting on huge gains like 266% in Celldex Therapeutics (Nasdaq: CLDX) in less than a year or 198% in Galena Biopharma (Nasdaq: GALE) in six months.

And it’s not just the small caps. Even most of the blue chip biotechs have had monster years.

Before the recent sell-off, Biogen Idec (Nasdaq: BIIB) was up 113% in the past year and Gilead Sciences (Nasdaq: GILD) soared 115%. These aren’t tiny penny stocks that doubled in price. These companies have market caps of $69 billion and $120 billion, respectively. To put that in perspective, Gilead’s market cap is higher than General Motors’ (NYSE: GM) and Ford Motor Co.’s (NYSE: F) combined.

Now’s your chance

This is a classic example of quality stocks getting punished for being in the wrong sector at the wrong time. While I understand traders taking risk off the table and bailing on speculative names, the large cap biotechs are a great opportunity.

These companies have tremendous pricing power and high margins. Once a drug is approved and on the market, they can generate a windfall of profits in a short period of time.

Look at a company like Amgen (Nasdaq: AMGN). The stock dropped 6% from its high. Amgen is projected to generate nearly $20 billion in revenue this year and $8.05 per share in earnings, giving it a forward P/E of less than 15.

Gilead Sciences’ shares have fallen even further. My research tells me that its hepatitis C drug Sovaldi is going to be a huge blockbuster. The drug costs $84,000 a year but is expected to be the most effective hep C treatment on the market.

Gilead’s shares trade at a more expensive 23 times forward earnings, but earnings per share are forecast to grow a whopping 36% per year over the next five years, due in part to Sovaldi.

The bathwater is in the process of being thrown out, but there’s still time to catch the baby before someone else does. The large cap biotech names should continue to produce profits for shareholders for years to come.

Marc Lichtenfeld is a senior analyst at Investment U. See more articles by Marc here.

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