Valuations for smaller biotechnology and internet stocks are stretched, the U.S. Federal Reserve warned in its Monetary Policy Report delivered to the U.S. Congress recently.
But writing in The MoneyLetter, John Stephenson, CEO of Stephenson & Company Capital Management in Toronto, argues that there are still biotech and internet stocks that are attractive for a variety of reasons. In fact, Mr. Stephenson says, they are fast growing industries in a low GDP environment, and investors typically pay a premium for growth.
Valuation for these two sectors is quite attractive when growth is factored in, such as in a PEG (price/earnings to growth) analysis, and the gap between the most and least expensive stocks in these two sectors is currently below average.
This is not 1999 all over again. While speculative stocks which trade at substantial premiums to the market are a fact of life, the spread between the highest and lowest names on a price-to-earnings basis is currently tighter than normal.
In fact, the P/E ratios of biotech firms have actually collapsed on higher earnings expectations, making them very attractive at current valuations.
Large-capitalization biotech appears much more attractive on a forward P/E basis than large-cap pharmaceutical companies such as Pfizer Inc.
Not only that, but a greater proportion of companies within the biotech and internet sectors are profitable, reflecting the fact these markets are more mature.
Additionally, the stocks are trading at substantially lower price-to-earnings ratios than in 1999.
The story is much the same in the technology group, where large-cap internet stocks such as Facebook offer substantially higher growth rates than “old” technology names (i.e., Microsoft and IBM).
Both Microsoft and IBM will be lucky to grow revenues in the mid-single digit range over the next twelve months.
The growth rate year-over-year for internet software companies such as Netflix and Priceline Group has revenue increasing at 16.4 per cent, while earnings are up more than 31.8 per cent over the prior year.
In biotech the year-over-year growth rates are even more compelling, with revenues soaring 42.7 per cent and earnings up a staggering 100.9 per cent.
What I Recommend
Top-line growth forecasts for the healthcare sector are higher than that of any other sector I follow.
And despite its shortcomings, I believe that Obama care will drive increasing volumes in 2014 and 2015.
Biotech is particularly attractive when compared with big pharmacy on both the growth and valuation dimensions.
I also believe that we are still in the midst of a multi-year period of innovation, with new product cycles coming to market. This has helped support a strong secular biotech market.
In addition, larger-cap biotech companies are entering an extended period of capitalizing on their pipeline success.
These firms are launching multiple new products that are expected to drive significant earnings upside, which in turn should also continue to push their stock prices higher.
One of the recognized leaders in biotechnology is Gilead Sciences (NASDAQ-GILD). The company’s flagship medication is its hepatitis C (HCV) franchise. There are an estimated 150 to 200 million people worldwide infected with hepatitis C.
The company also has a very strong HIV franchise, and is poised to generate estimated revenues of $500 million to $1.5 billion (or more) from its oncology business unit.
I also see Gilead generating substantial free cash flows, which could generate financial returns via new clinical programs, or alternatively be returned to shareholders.
I have a buy rating on the stock and a 12-month target price of $106 dollars per share.
Another company in the biotechnology space that I like is Amgen Inc. (NASDAQ-AMGN). The company is best known for a family of drugs used to prevent infections in patients undergoing cancer chemotherapy, and Enbrel, a tumor necrosis factor blocker used in the treatment of rheumatoid arthritis and other autoimmune diseases.
The company has been very conservative on its guidance, suggesting there is plenty of room for upward revisions and that the pipeline of new product developments has not been figured into the stock price.
As well, Amgen is focused on continued dividend growth, which is attractive for long-term investors. I have a buy rating on the stock and 12- month price target of $140 per share.
One of my favorite internet companies is Netflix (NASDAQ-NFLX).
This company is one of the best derivatives off the strong growth in online video viewing and internet-connected devices, such as tablets, smart phones and internet TVs.
It has turned the traditional broadcast television market on its head by creating some extremely popular original programming, including House of Cards and Orange is the New Black.
Netflix, with its 31 million U.S. subscribers and eight million international subscribers, has a sustainable level of scale, growth and profitability. I have a buy recommendation on the stock and a 12- month price target of $540 per share.
The MoneyLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846