There is much talk about a bubble in the stock market, but do we need to be concerned? The question is whether we will experience a dot-com bubble or housing bubble again. The answer is that no one knows, however, today it seems people are, instead of a tech bubble, afraid of a biotech bubble. According to Bloomberg News, have Nasdaq's biotech companies given a return of 500% to shareholders, compared with 97% for the Nasdaq's Internet stocks. Investors' pessimism becomes clear when we look at the short interest ratio that have doubled for the Nasdaq Biotechnology Index since 2013, according to data from Bloomberg. Nasdaq is currently traded at average 2.3 times annual sales while their biotech companies are trading at 10 times annual sales.
There is a lot of nervousness in the market, one or two earnings misses could trigger a broader sell-off...
Low interest rates are probably one reason why investors are clamoring for risky assets right now. Listed tech stocks have also risen a lot lately, but valuations are not as high as biotech, for the most part. Something that may contribute to the biotech run-up could be that companies such as Uber and Snapchat wait longer before an IPO. Investors who are looking for high-growth companies have hence had more biotech stocks to choose from. Biotech stocks accounted for about 25% of the 275 IPOs launched last year in the US, says the research firm Renaissance Capital. Biotech stocks that went public in the last two years has on average risen 78%, that is three times higher than non-biotech stocks that went public over the same time.
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In the picture above you see that biotech stocks have risen faster than any other sector of the market for the past four years. This has never happened before in the US, healthcare have set records for both IPOs and M&A spending. There are 44 biotech companies in the US that has a valuation of $2 billion, a year ago they were 26. In conjunction with biotech companies successes has venture capital investments in the industry increased by 29% last year to $6 billion. This has made biotech to the second largest investment sector after software, according to PwC. Investors and big pharma firms have been showering billions on speculative companies that have never produced a viable drug. However, there is a variety of companies and we see biotech companies that really are making innovative drugs and treatments that could cure rare diseases.
Janet Yellen mentioned that she was worried about what was going on in the biotech, that it was a sector where valuations looked "stretched"...
There are several reasons to be worried about a bubble, but can we really say that the biotech industry is overvalued that some people claim? Drug approvals have increased with 10-20% by the US Food and Drug Administration and the European Medicines Agency compared to historical norms. This positive statistics is used as an argument to show that we are not in a biotech bubble. Hartaj Singh, an analyst at BTIG, rejects the claims that biotech is overvalued. "I think valuations are fine," he said. However, he also said that there is a lot of nervousness in the market, one or two earnings misses could trigger a broader sell-off. "It might not be pretty."
Neil Woodford, a well-known fund manager in the UK, has a different view on the sector. "There's a bubble in some parts of the quoted biotech sector, not necessarily here but certainly in the US there's some pretty punchy valuations. But that does not describe the biotech valuations everywhere." It's no news that the valuations in the US are considered to be high. Last year did the Federal Reserve chairman Janet Yellen mentioned that she was worried about what was going on in the biotech, that it was a sector where valuations looked "stretched". But when she was asked again she declined to comment, perhaps she is concerned that investors will start to worry about a bubble in the market.
Waiting for the biotech bubble to burst with cash ready may be a good idea. Or maybe doing that will cause you to miss the train. Who knows?
There is no strong consensus what the market believes, therefore it's difficult to know how one should interpret today's valuations. Some say it's a bubble while others say the opposite, it gets even more confusing when some say that there is a bubble in some parts of the market. I myself don't own any biotech stocks at the moment, the reason is simply that I'm not sufficiently well-read in biotech. I can't say that it has to do with valuations, although they are quite high. If you want to invest in a biotech I would recommend having it make up a small part of your portfolio. Waiting for the biotech bubble to burst with cash ready may be a good idea. Or maybe doing that will cause you to miss the train. Who knows?
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