Biotech Stocks: Invest in Biotech, But at Your Own Risk

Fed Chair Janet Yellen testified before the US Senate Committee on Banking, Housing, and Urban Affairs. She presented the Fed’s semiannual Monetary Policy Report (MPR) to the Congress. In her prepared remarks, she stated that while valuation seems “stretched” in some areas of the bond market, equities “remain generally in line with historical norms.”

Yet in the MPR, which bears her signature, the following observation appeared: “Nevertheless, valuation metrics in some sectors do appear substantially stretched–particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.”

In other words, in her opinion, the stock market is showing some signs of irrational exuberance. Of course, this term was popularized by Fed Chair Alan Greenspan in a speech on December 5, 1996 indicating his concern about a possible bubble in stock prices. About two years later, on January 28, 1999, in testimony before a Senate Committee, he defended the mania in Internet stocks by offering his Lottery Principle.

Biotech Stock News

In any event, industry analysts have been scrambling to raise their earnings estimates for S&P 500 Biotechology industry. They now expect earnings to rise 38.7% this year and 13.6% next year compared to forecasts of 15.8% and 17.8% at the beginning of the year.

Forward earnings has soared 64.3% y/y through mid-August. Consensus expected earnings growth over the next five years is around 19% per year, up from 11% in 2011. The stock index is at a record high, up 23.4% ytd and 56.5% y/y, after a brief swoon during March and April. Yet the forward P/E has actually declined from this year’s peak of 24.0 during the week of January 23 to 16.1 currently.

Biotech News Video

Watch this video for more “Biotech” news.

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Biotech Financial News

Within days of Yellen’s testimony, Facebook, Google, and Twitter all reported better-than-expected results for Q2 earnings. The S&P 500 Internet Software & Services stock price index is up 17.0% from this year’s low on May 8. Forward earnings rose to a new record high in mid-August. The stocks seem expensive with the forward P/E around 20. But that’s also the expected annual growth rate for earnings over the next five years.

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