Posted on: Sunday, May 16, 2004
Be wary in following biotech's upswings
By John Waggoner
USA Today
If the fields of grain near your house are not only waving, but clapping and singing, too, then you've experienced some of the wonders of biotechnology.
But it's more likely that you'll experience biotechnology in new medical treatments. And that's what has made biotech stocks grow so rapidly the past 12 months.
The sector's big gains, though, should start warning bells ringing for anyone who has ever watched biotech wilt before. If you want to invest in biotech now, you're probably better off investing in a healthcare fund, which can maneuver into slightly less risky medical fields.
The biotech industry has had remarkable achievements the past decade, ranging from human growth hormone, which treats growth hormone deficiency in children, to Botox, which helps erase those nasty frown lines. The industry also has figured out how to make insulin, used to treat diabetes.
The Martha Stewart trial also boosted public awareness of biotech. She was accused of selling her shares of ImClone in 2001 based on illegal inside information that its cancer drug Erbitux would not be approved by the Federal Drug Administration. Ironically, the FDA approved the drug for treatment of advanced colorectal cancer in February.
The past 12 months, the Nasdaq Biotech index has gained 35 percent, versus 19 percent for the Standard & Poor's 500-stock index. Some of the biotech gains have been truly startling:
• Northfield Laboratories, which is working on an alternative to blood, called PolyHeme, for transfusions has jumped 131 percent the past 12 months.
• Sepracor, which makes an asthma treatment called Xopenex, has leaped 155 percent.
• Genentech, a pioneer biotech company, makes Raptiva, a psoriasis treatment. It's up 238 percent.
Gains like that, particularly in today's snake-bitten market, tend to attract investors' attention quickly. Another reason to like biotech:
Major drug companies don't have many new blockbuster drugs in the development pipeline. So they're buying new drugs from biotech firms — and, in some cases, buying the biotech firms outright.
Furthermore, biotech, like technology in general, has a certain cachet. It conjures up images of lone geniuses discovering cures for mad cow disease, and of stocks that soar from 20 cents to $20 in a day. There's an element of truth to this.
Be cautious
Unfortunately, biotech also has well-deserved reputation for periodic meltdowns. Genentech, for example, plunged 66 percent from February 2000 through September 2002. And buying the entire industry didn't provide much diversification: Fidelity Select Biotechnology fell 66 percent the same period.
For potential investors, then, the question is whether biotech is close to bubbling over. One indication is the type of biotech companies that are doing well. In fairly rational times, companies with real earnings and FDA-approved products tend to lead the pack. As the biotech frenzy starts to heat up, investors start bidding up the prices of companies with no earnings, but decent prospects of FDA approval of a new product. Eventually, you'll see many initial public stock offerings in the field, some of which have little more going for them than a few guys with a microscope and a petri dish.
We're not there yet. But Erin Xie, manager of State Street Research Health Sciences, thinks the biotech sector is starting to mutate into a speculative phase. "We see people's interests move from late-stage projects to earlier and earlier-stage companies," she says.
You can make money in those kinds of companies, but you can also lose everything you invest — something biotech investors seem to forget every five years or so. "It's intrinsically chancy," Xie says.
She thinks the biotech market is fairly valued now, which means any big move to the upside would come with increasing risk. And bear in mind that "fairly valued," in the biotech world, means valuations that would make your blood pressure soar in almost any other industry. Genentech, for instance, sells for 78 times its estimated earnings for the next 12 months. Drug giant Merck sells for about 15 times earnings.
J.C. Waller, manager of ICON Healthcare, agrees with Xie's assessment and says the biggest biotechs are the most overvalued of all. Interestingly, smaller biotech companies with real earnings are somewhat overvalued, he says. Biotech is just 6.5 percent of Waller's portfolio.
Healthcare opportunities
Just because biotechnology may be headed for the intensive care ward is no reason to overlook the entire healthcare industry. After all, the nation's 77 million
baby boomers — those born from 1946 to 1964 — are lurching from middle to old age. As they get older, they will need more healthcare. That's a long-term trend that won't go away soon.
Waller thinks that stocks of managed healthcare companies, such as Anthem, are the best in the sector. The company has gained 37 percent the past six months and sells for 7.6 times estimated earnings.
Some day, scientists will find cures for cancer, the common cold or other diseases — and, one hopes, without any major mishaps. Life is peculiar enough without fields of whistling beets. But if you want to make a slightly less risky bet, try a healthcare fund instead.
