“One day you’re a prince, the next day you’re a slave.” That’s a line from the track Prodigal by Casting Crowns — a favorite of mine. And it recently came to mind when I was thinking about how to describe the current situation for biotech stocks.
Earlier this year, iShares Nasdaq Biotechnology Index (ETF) (IBB) — which had managed 170% gains over the past five years — had fallen from a July 20, 2015 high of $398 per share to a low of $244.04 on Feb. 11 of this year.
That’s a nearly 40% decline in just half a year!
You probably already know that the depressed nature of biotech stocks has a lot to do with politics; for instance, presidential aspirant Hillary Clinton threatening to rein in drug prices if elected into office. As I have discussed in the past, the worry is genuine and it’s enough reason for stocks to lose their value.
Still, we’ve seen a number of rallies in patches while the biotech industry was heading south. Another rally started in May. Now, there are questions among investors about whether this rally is sustainable — exacerbated by today’s huge drop-off in IBB amid a double-digit hammering of Biogen Inc (BIIB) and Alexion Pharmaceuticals, Inc. (ALXN), which make up a combined 12% of the Nasdaq biotech ETF.
In essence, is it time to buy biotech stocks?
The End of the Rally Shouldn’t Deter You
As with all rallies, the current rally in the biotech index will come to an end again, especially as election draws near. The reality is, investors can’t know what would become of drug pricing until we have a new president of the United States. By implication, investing in biotech stocks based on its rally would be a shallow move, which could come back to hurt even the most experienced of traders.
One thing is sure, though, the biotech industry won’t sink into oblivion regardless of who becomes the next U.S. president.
However, it should be said that the risk of buying any one biotech stock right now is high, as individual stocks are likely to react the most to a legislation change — or rumors of it.
The IBB ETF: The Best Way to Play Biotech Stocks
But since the industry as a whole isn’t going anywhere, as I’ve just said, a safer way to invest in biotech, regardless of any regulation changes, is to invest in an industry ETF like iShares Nasdaq Biotechnology. Assuming you’re a long-term investor. Here’s why.
The IBB ETF is designed to track U.S. biotechnology and pharmaceutical companies. In essence, there is diversification here.
Regulations might affect individual companies, but won’t affect the entire industry. That’s essentially because one company’s loss is another company’s gain.
On one end, stringent pricing regulation might affect the top line of companies like Valeant Pharmaceuticals Intl Inc (VRX), which Clinton specifically accused of price gouging (VRX is currently down double-digits), or Amgen, Inc. (AMGN), which admitted in a quarterly earnings report that the sales of some of its drugs increased due to price increases.
On the other end, companies whose growth is not dependent on price increase won’t be all that affected. These ones would gain.
So investors who hold stocks in the “price gouging” category are exposed to higher risk here. And in such a case, chances are investors in these companies would have lost some money, making it more daunting to switch to the least exposed stocks.
While on the surface, IBB is also exposed to this risk (as Amgen is its top holdings), the damage would be temporary.
On the IBB prospectus page, it’s clearly stated that “holdings are subject to change.”
By implication, if any of the biotech ETF’s holdings become unreliable, IBB can reallocate its assets accordingly.
Yes, value may drop temporarily, but with the advantage of tracking an entire industry, the value of the Nasdaq biotechnology ETF will eventually improve again.
Long story short, the best way to play biotech stocks at present is to invest in the IBB ETF.
As of this writing, Craig Adeynaju did not hold a position in any of the aforementioned securities.
