Industry Spotlight

6/2/2014


You can do better than biotech

In 2013, S&P 1500 Index biotechnology stocks averaged total returns of 65%, third-highest among the 54 industries with at least 10 stocks. But in the past three months, none of those 54 groups has fared worse than biotech, which averaged a loss of 10%.

Despite the weakness, biotech stocks still look pricey, as shown in the nearby table. The average trailing P/E ratio for S&P 1500 biotech stocks is 36, still well above its 10-year average of 28. Biotech trades at a discount to historical norms based on price/sales, but the average of 9.7 is still nearly triple the sector average. These stocks also remain unusually expensive compared to the broader health-care sector. Making matters worse, 12-month sales and per-share-profit growth for biotech companies has been soft relative to both the sector average and their own 10-year averages.

BIOTECH STILL NOT CHEAP
Despite the slump in S&P 1500 biotechnology stocks in recent months, they still look unusually expensive relative to the broader health-care sector, while sales and profit growth were softer than normal. All numbers are averages.
Period
S&P 1500
Biotech
Industry
S&P 1500
Health-
Care Sector
Spread: Biotech
Industry Minus
Health Sector
Trailing P/E ratio
Recent
36.0
24.8
11.2
10-yr. average
27.6
22.4
5.2
Forward P/E curr.-yr. est.
Recent
27.4
22.4
5.0
10-yr. average
24.5
20.3
4.2
12-mo sales growth (%)
Recent
9.9
8.5
1.4
10-yr. average
14.3
11.9
2.4
12-mo. EPS growth (%)
Recent
2.9
2.8
0.1
10-yr. average
9.7
9.0
0.7
Note: P/E ratios below zero or above 75 excluded. Also excluded are sales or EPS (earnings per share) changes of more than 75%.

Beyond valuations and slower growth, two additional factors make us reluctant to place bets on individual biotech companies, which base their treatments on microorganisms or biological materials, rather than the chemical formulations used by traditional drugmakers.

First, it is difficult to gauge the effectiveness of research efforts that will not begin to pay off for many years. The nine largest U.S. biotech companies (market values above $5 billion) spent an average of 34% of their revenue on research & development last year — 2.5 times the average for similarly large pharmaceutical companies. The combined R&D budget for those large biotech companies rose at annualized rate of 8% over the past five years, while drugmakers cut spending.

Second, biotech firms face especially high company-specific risks. The breadth of the product portfolios at most big pharmaceutical companies helps to absorb the sting from poor clinical trials, regulatory delays, or new competition. But biotech companies tend to hold smaller portfolios.

While we don't recommend any biotechs for purchase, our favorites are A-rated Amgen ($116; AMGN) and Gilead Sciences ($82; GILD). United Therapeutics ($99; UTHR), which we don't cover, also has appeal, though it must be considered speculative. Investors who wish to own biotech might be better off avoiding individual companies, instead buying an exchange-traded fund such as iShares Nasdaq Biotechnology ($239; IBB), which earns a mutual-fund score of 89.

THE BIGGEST S&P 1500 BIOTECH STOCKS
The S&P 1500 Index includes 16 biotechnology stocks, nine with market values above $5 billion. The four stocks in bold are monitored by the Forecasts. Amgen and Gilead are rated A (above average), the others B (average).
Stock-
Market
Value
($Bil.)
Total Return
---- P/E Ratio ----
Est. EPS
Growth,
Curr. Yr.
(%)
Quadrix Scores
Company (Price; Ticker)
3
Month
(%)
2013
(%)
Trailing
Forward
Value
Overall
Alexion Pharma.
($168; ALXN)
33.9
(8)
42
42
35
58
16
79
Amgen ($116; AMGN)
89.0
(6)
35
15
14
6
57
59
Biogen Idec ($310; BIIB)
73.7
(11)
91
33
27
28
21
73
Celgene ($155; CELG)
65.5
(6)
115
25
21
22
31
65
Cubist Pharma.
($67; CBST)
5.7
(16)
64
55
45
3
11
13
Gilead Sciences
($82; GILD)
138.0
(2)
104
27
13
204
35
91
Regeneron Pharma.
($308; REGN)
34.5
(9)
61
36
31
21
13
46
United Therapeutics
($99; UTHR)
5.6
(2)
112
22
12
147
62
88
Vertex Pharma.
($73; VRTX)
17.1
(13)
77
 NA 
 NA 
NA
7
12
S&P 1500 group (number of companies)
Biotechnology
average (16)
29.3
(10)
65
36
27
15
26
47
Pharmaceuticals
average (21)
52.0
4
62
25
21
13
36
55
Health-care
average (153)
16.8
(1)
49
25
22
9
46
54
Note: Quadrix scores are percentile ranks, with 100 the best.

Big, stodgy tech stocks stand out

Most technology stocks seem to be catching their breath after setting a torrid pace in 2013. Among current S&P 1500 Index technology stocks, 84% generated a positive total return last year, but just 48% have done so in 2014. With much of the sector struggling to build on last year's gains, one group has proved particularly resilient: big, stodgy tech.

TECH GIANTS LOOK MIGHTY TEMPTING
By separating the S&P 1500 technology sector into quintiles by current market value, we find the largest stocks look particularly attractive right now. Big, stodgy tech, a group of bellwethers detailed in the table at the bottom of the page, have broken out this year, while many smaller stocks have suffered sharp declines. All numbers are averages.
Stock-
Market
Value
($Mil.)
YTD
Total
Return
(%)
----- P/E Ratio -----
Est. EPS
Growth.
Curr. Yr.
(%)
Div.
Yield
(%)
Quadrix Scores
Technology Group
(Number Of Companies)
Trailing
Forward
Value
Overall
Biggest
quintile (52)
66,038
6
20
19
9
1.5
54
71
Second-biggest
quintile (52)
5,657
4
23
22
10
0.6
53
62
Middle
quintile (52)
2,236
5
22
20
16
0.6
54
63
Second-smallest
quintile (52)
1,196
(3)
22
20
6
0.5
58
63
Smallest
quintile (51)
436
(11)
27
27
8
0.6
51
38
S&P 1500 tec
h stocks (259)
15,169
0
23
21
10
0.8
54
59
Note: Quadrix scores are percentile ranks, with 100 the best.

To define this collection of bellwethers, we identified the 10 biggest technology companies by market value a decade ago. Among those companies, Dell was taken private last fall for $24.9 billion, while Motorola split into two separate companies in 2011. The other eight companies, shown in the table below, remain key players in the sector today and still have market values in the top 20 for the technology sector.

Although the stock market tends to become infatuated with shiny — and often unprofitable — start-ups, staying power still counts for something. Seven of the eight tech titans have produced a positive total return so far this year.

Superior performance aside, the big companies boast P/E ratios substantially lower than the sector average. Somewhat more surprising, investors need not sacrifice much profit growth. As a group, big, stodgy tech is expected to average 7% growth in per-share profits in the current fiscal year — roughly in line with the smaller tech stocks and not too far below the sector's overall average of 10%.

That combination of cheap valuations and solid growth outlooks could position the big, stodgy tech stocks for more gains. It's also worth noting that they average higher Quadrix Overall scores (86) and Value scores (73) than their sector peers. Within this group, we recommend Qualcomm ($80; QCOM) as a Buy and Long-Term Buy and Cisco Systems ($25; CSCO) as a Long-Term Buy, while four of the other six earn A (above average) ratings.

BIG, STODGY TECH
Below are tech stocks among the 10 biggest by market value 10 years ago that remain in the top 20 today. They have averaged a 7% total return in 2014, while the average S&P 1500 tech stock has been flat. Stocks recommended for purchase are listed in bold. Intel, IBM, Microsoft, and Oracle are rated A (above average).
Stock-
Market
Value
($Bil.)
Market-Value
Rank Among
S&P 1500 Tech
Est. EPS
Change,
Fiscal
2014
(%)
Est.
5-Year
Annual.
EPS
Growth
(%)
---- P/E Ratio ----
YTD
Total
Return
(%)
------- Quadrix Scores -------
Company (Price; Ticker)
5/26/04
Current
Div.
Yield
(%)
Trailing
Forward
Momen-
tum
Value
Overall
Cisco Systems
($25; CSCO)
128.0
3
10
3.1
1
8
 12 * 
12
12
51
83
94
Hewlett-Packard
($33; HPQ)
63.4
6
13
1.9
4
4
 9 * 
9
19
67
95
93
Intel ($27; INTC)
136.7
2
8
3.4
0
10
14
14
5
60
80
92
IBM ($185; IBM)
192.5
4
4
2.4
5
11
 11 * 
10
0
38
91
82
Microsoft ($40; MSFT)
336.3
1
3
2.8
2
8
15
15
9
32
62
67
Oracle ($42; ORCL)
191.7
7
5
1.1
9
10
 15 * 
14
10
60
70
93
Qualcomm ($80; QCOM)
138.3
8
7
2.1
14
13
 18 * 
15
9
41
63
84
Texas Instruments
($46; TXN)
50.8
10
16
2.6
18
10
22
19
7
89
40
84
Big, stodgy tech
average               
154.7
2.4
7
9
15
14
7
55
73
86
* Trailing P/E lags three-, five-, and 10-year averages.      Note: Quadrix scores are percentile ranks, with 100 the best.

 


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