The summer of 2015 marked the end of the glory years in the biotechnology sector. And while the NASDAQ Biotechnology Index has not yet recovered, it is still well above the lows of late 2016. Even though there are political, valuation and fundamental headwinds ahead for biotech stocks, investors can still do well owning biotech ETFs.
The biotech valuation correction that lasted over two years may be coming to an end. Some well-known, large-cap names — such as AbbVie Inc (NYSE:ABBV) and Pfizer Inc. (NYSE:PFE) — are currently trading at forward P/E multiples in the 10+ range. This level probably won’t last forever, especially with the impressive levels of innovation by biotech firms.
So how should investors get exposure in the red-hot, but risky sector?
Consider an Equal-Weight Biotech ETF
First, investors need to assess the political risks ahead. The government is cutting the layers of bureaucracy between the FDA and drug companies. By shortening the amount of time it takes to get drug approvals, the government is introducing competition, lowering R&D administrative costs and encouraging innovation.
That would favor the SPDR S&P Biotech ETF (NYSE:XBI). This fund’s stocks equally weighted, and investors hold a basket of companies that are mid-cap and smaller. On the chart, XBI is showing a “double top” at its 52-week high of $97.98. This doesn’t predict a correction, but investors should be aware that selling pressure picks up at that price. XBI traded below $70 less than a year ago.
XBI’s top 10 holdings include Sarepta Therapeutics Inc (NASDAQ:SRPT) — a stock I thought would rebound last year. It did more than that: the stock is up 62 percent in 2018 and nearly doubled in the last year.
Considering Bigger Biotech ETFs
The slump in large capitalization biotech stocks is holding back the performance of the market-cap-weighted iShares Nasdaq Biotechnology ETF (NASDAQ:IBB). Note that this ETF only tracks Nasdaq-listed biotech companies, so “IBB may miss opportunities in companies traded on the NYSE, which several of the other biotech funds are eligible to hold.”
The downtrend in Amgen, Inc. (NASDAQ:AMGN) stock is weighing IBB lower. Even though it pays a dividend yielding almost 3 percent, Amgen is underperforming because of weak 2018 guidance. Celgene Corporation (NASDAQ:CELG), which is 7.14 percent of the IBB, sold off recently on no news, bottoming at $74.13 before heading towards $80. The market is skittish over its $9 billion purchase of Juno Therapeutics. This followed with Celgene receiving a Refusal to File letter from the FDA pursuant to ozanimod, a relapsing multiple sclerosis drug.
Celgene stock currently trades at a forward P/E of 7.7.
Gilead Sciences, Inc. (NASDAQ:GILD), which made its billions from selling a hepatitis C vaccine and drugs treating HIV patients, makes up 7 percent of the IBB ETF. At the Bank of America Merril Lynch conference, Gilead said that the HIV franchise is a very healthy business that it expects will grow.
To sustain longer-term growth, Gilead will need additional assets. But as of now, management is happy with the progression of its pipeline. With Gilead trading at a forward P/E around 10 and with a dividend yield of 3.5%, the sluggish performance of GILD stock should not bother patient investors.
Bottom Line for Biotech ETFs
If companies like Gilead deliver on new product launches then the discount to fair value will narrow for the IBB and XBI biotech ETFs. Value investors holding these ETFs for the longer-term — at least three years — will be rewarded.
Timing the end of the downtrend in biotech or picking individual companies is a fool’s game. Buying a Biotech ETF is a better approach that takes out the guessing game.
Disclosure: Author does not own shares in any of the companies mentioned. Financial models provided by finbox.io