The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.
Earnings are supposed to matter. But that little bit of Investing 101 may need to be thrown out of the window when it comes to biotech stocks.
The biotech sector has staged a remarkable comeback from its lows earlier this year. The group was sold off hard along with other momentum darlings as the market worried about high valuations. That's no longer a concern. For now, at least.
Just look at the acquisition announced Monday morning: Merck (MRK) agreed to pay $3.85 billion in cash for biotech Idenix (IDIX), an unprofitable developer of a hepatitis C drug. The deal valued Idenix at ... wait for it ... a nearly 240% premium to its Friday closing price.
Take a minute and think about that. The stock finished last week at $7.23, By Monday morning, Merck had decided it was worth $24.50.
Idenix was already up more than 20% this year before the Merck deal. It's not the only money-losing biotech to surge lately either.
Achillion (ACHN), another maker of a hep C medication, has surged more than 125% in the past two days thanks to good news from the FDA about its own hepatitis C drug as well as speculation that it too could be acquired.
MannKind (MNKD), which is developing drugs to treat diabetes and various types of cancers, has more than doubled this year. And InterMune (ITMN), which works on lung-disease drugs, has soared more than 180%.
And the rally may not be over. John Eade, a health care analyst and president of Argus Research, said the biotech sector is in the midst of a "research and development renaissance." The companies that Big Pharma will covet the most are those that are working to treat infectious diseases like hep C as well as those focusing on diabetes and oncology.
Craig Callahan, CEO of ICON Funds, said another reason more biotech buyouts make sense is because Big Pharma has the marketing and sales expertise that smaller biotechs lack. And Big Pharma is desperate for new blockbusters in their pipeline. In fact, a certain 80s hit by Huey Lewis and the News could be the industry's theme song.
Callahan added that the biotech sector is now the largest in the ICON Long-Short fund, mainly because there are few other areas that offer as much potential for growth over the next few years.
But investors need to be really, really careful.
"There are going to be more deals between Big Pharma and biotech," says T.J. Qatato, co-manager of the Frost Growth Equity fund. "But we are looking for more consistent, stable growers with proven trial results." His fund owns big biotechs Biogen (BIIB), Celgene (CELG) and Gilead Sciences (GILD).
Paul Condrat, co-manager of the Davidson Multi-Cap Equity fund, agrees. He thinks larger biotechs are better investments for the long-term than the more speculative ones. They also can benefit from deals. He owns Amgen (AMGN) and points to the company's purchase last year of cancer drug developer Onyx.
Condrat also owns Gilead, which already has a hepatitis-C drug on the market -- a drug that it acquired the right to when it purchased biotech Pharmasset in 2011. Shares of Gilead fell on Monday due to concerns about the Merck-Idenix deal. But he thinks that's an overreaction.
Callahan recommends that investors take on a little more risk though. He thinks that the biotech sell-off earlier this year was just a blip. Fears that the market may have topped and that the U.S. economy was heading into a more pronounced slowdown have faded.
"The theme of investors embracing recession-proof, high dividend stocks may be behind us. Investors are back to buying last year's winners, high-growth stocks like biotech as well as cyclical companies," he said.
Still, investors must remember that biotech is extremely risky. You need to know more about the companies than their earnings growth rates and valuation metrics. Smaller biotechs often rise and fall based on clinical trial results ... and that's the kind of information they teach in medical school as opposed to an MBA program.
That's why Joe Costigan, director of equity research at Bryn Mawr Trust, thinks that investors may be better off with larger, more mature (i.e. profitable) biotechs like Amgen as well as Big Pharma firms that may look to scoop up smaller, riskier biotechs, such as Novartis and Pfizer (PFE). His firm owns all three stocks.
Those companies can afford to pay 240% premiums for smaller biotech firms because the downside is limited if the deals doesn't pan out. If you're an average investor trying to pick the next Idenix, it's not easy to do so. And you probably don't want to lose your shirt trying to figure out what unprofitable biotech could get bought next.
"If you own the right biotech company, you can do well. There will be a couple of home runs, even grand slams. It is a land grab for Big Pharma," Costigan said. "But the vast majority of companies will not be hits -- and you need to understand the underlying science."
After taking a short breather, U.S. investors re-entered the U.S. stock market last week.
Investors added $849 million to U.S. stock mutual funds during the week ended March 13, according to the latest data from the Investment Company Institute. That marks the first inflow after two weeks of modest outflows.
The return to stocks came in the middle of the Dow's 10-day winning streak, during which the blue chip index also closed MOREHibah Yousuf - Mar 21, 2013 2:00 PM ET
After yanking more than $150 billion from U.S. stock mutual funds last year, investors began to put their money back into the market at the start of 2013. A lot of it.
U.S. stock mutual funds gained $8 billion in the week ended Jan. 9, according to the Investment Company Institute. That's the highest amount since the ICI began keeping records in 2007.
The big flood of money came as the MOREHibah Yousuf - Jan 17, 2013 10:02 AM ET
U.S. investors plowed a record $183 billion into U.S.-listed exchange traded funds last year, surpassing the previous record of $178 billion set in 2008, according to State Street data.
"Last year's impressive overhaul amounts to yet another clear sign that ETFs are not only here to stay, but are increasingly chipping away at the dominance of mutual funds," said Olivier Ludwig, managing editor at IndexUniverse, which also tracks ETF assets.
Like mutual MOREHibah Yousuf - Jan 11, 2013 2:35 PM ET
The U.S. stock market has been on a bull run since early 2009. At the same time, individual investors have been pulling billions of dollars out of stocks each year.
As the S&P 500 rallied about 13% during the first eleven months of 2012, individual investors yanked about $152 billion from the U.S. stock market, according to data from EPFR Global, a Boston-based firm that tracks fund flows for both mutual MOREHibah Yousuf - Dec 27, 2012 7:32 AM ET
Facebook will make its way into the Nasdaq-100 (NDX) next week, but the social network could find itself in the even more widely tracked S&P 500 (SPX) soon enough, too.
According to Standard and Poor's methodology, "initial public offerings should be seasoned for 6 to 12 months before being considered for addition to an index." Facebook (FB) just celebrated its six-month birthday as a public company a little over two weeks ago.
While MOREHibah Yousuf - Dec 6, 2012 1:41 PM ET
Bond king Bill Gross says it's time for individual investors to get used to a new (and slower) dance.
In his monthly investment outlook letter, the founder of Pimco and manager of the world's largest bond fund, Pimco Total Return Fund (PTTRX), wrote that the age of credit expansion that led to double-digit portfolio returns is over, and the age of inflation has begun.
And that means investment returns from both stocks and MOREHibah Yousuf - Sep 5, 2012 2:07 PM ET
Investors continued to bail out of U.S. stock mutual funds last week, despite a rally in the market fueled by an upbeat July jobs report and hopes that central bankers will soon step in to support financial markets.
Investors pulled $3.6 billion out of U.S. stock mutual funds during the week ended Aug. 8, according to Investment Company Institute. While the pace of outflows slowed considerably from the prior week, when MOREHibah Yousuf - Aug 16, 2012 2:04 PM ET
Investors' appetite for ETFs continues to grow.
As of May 31, the U.S. ETF industry had over $1.1 trillion in assets under management, spread across 1,251 funds, according to data from State Street.
ETF inflows totaled more than $60 billion during the first five months of 2012. The Vanguard MSCI Emerging Markets ETF (VWO) had $8.1 billion in inflows, making it the most popular ETF so far this year. Running a close MOREBen Rooney - Jul 11, 2012 4:48 PM ET
Not a member yet?Sign up now for a free account
|NFL gets billions in subsidies from U.S. taxpayers|
|Bill Gates: 'I feel pretty stupid that I don't know any foreign languages'|
|Are smart drugs driving Silicon Valley?|
|The most important investing rule|
|January was a terrible month for stocks|