Biotech Could Get Knocked Down a PEG -->
By Lissa Morgenthaler
Special to TheStreet.com
Originally posted at 9:43 AM ET 7/10/01 on RealMoney.com
thestreet.com
Biotech looked as if it might be making a rounding top on its way to testing
the March 22 to April 4 lows. I found the Nasdaq Biotech Index's (IBB:Amex
- news - commentary) perfect 61.8% Fibonacci retracement from its lows
simply weird --- as in, how does it know?
Even with so many technical analysis investors out there, how does an index
know that it has retraced 61.8% of the fall from its highs and it's due to fall
again? Are enough investors paying attention to these charts that their
simultaneous trades move stocks around like toy boats?
The Nasdaq Biotech Index
How does it know it's retracing its lows?
Lehman Brothers biotech analyst Rachel Leheny made a notable point at
last week's big Biotechnology Industry Organization meeting in San
Diego. (You know, the big meeting that was supposed to have all the
protesters? You probably saw it featured repeatedly on television.) Leheny
observed that biotech is trading at a PEG ratio of 2.7, which caused some of
us to take a deep breath -- the way you would if the captain of your ship said,
"We're goin' down."
If you haven't played with PEG ratios before, they're the price-to-earnings ratio
of a stock divided by its growth rate. That is, P/E divided by G. PEG ratios are
often used to justify what I regard as some fairly silly valuations (though, as
Herb Greenberg says, never short a stock based simply on its valuation).
Over the past few years in this schizoid market, a PEG ratio of 2 has been
regarded as normal. For example, Genzyme (GENZ:Nasdaq - news -
commentary) will probably earn about $1.15 a share this year, and its stock is
trading at $57. So that's a P/E of nearly 50 on a company expected to grow
roughly 23% this year. Fifty divided by 23 gives you a PEG ratio of
approximately 2.2, which in the market of the past year was regarded as a
reasonable multiple to pay for a stock.
A PEG ratio adjusts for a high P/E when a company is growing fast. The
theory behind this rationale is that we investors are (and should be) willing to
pay more for a fast-growing earnings stream than for a big, fat slug of a
company with no growth at all. I presume PEG ratios and GARP (growth at a
reasonable price) grew up together, and I think both rationalizations have
enticed people into many investments they later regretted.
So when Leheny explained last week that PEG ratios for biotech were 2.7, it
got my attention. Only about 20 biotech companies have enough "E" to
support a PEG. Normal PEGs for biotech stocks are more in the range of 2.0
to 2.3. Thus, a PEG of 2.7 is darned high for biotech. By contrast,
pharmaceutical stocks are trading at a PEG of 1.7, and tech is trading at a
PEG of 1.0. (Or as a humorous fund-manager friend snorted last week, "Tech
doesn't have any growth!)
In this environment, I look at the amount of money flowing into biotech and
know the tide for biotech stocks is rising. Then I look at the understaffed
Food and Drug Administration, where the head count has dropped 10%
over the past few years. The FDA has had no cost-of-living adjustment
recently, and the life-sciences companies are recruiting FDA officials like
crazy. Meanwhile, the number of drug-approval applications is skyrocketing,
while drug approvals are supposed to accelerate. But without an FDA
commissioner and with morale in the dumps, FDA drug-approval times have
slowed from the sizzling 12-month pace a year ago to 18 months on average.
(Adam Feuerstein penned this phenomenon several weeks ago.)
Then I look at the constraints on biotech manufacturing, where it takes at
least two years to secure FDA approval of a protein-manufacturing facility.
There are such capacity constraints in biotech right now that we won't see
enough manufacturing space for at least five years. It's precisely this problem
that has given Immunex (IMNX:Nasdaq - news - commentary) such a
headache, about which Nadine Wong wrote last week.
I also look at the wackiness coming out of the U.S. Patent Office, where
patent examiners are on probation for their first year. (They're paid $50,000 to
hit a quota of patents or they're outta there.) Examiners have 13 to 19 hours
over a two-year period to review a patent application, and patent applications
in the life-sciences area have been rising 22%. That's more than any other
area, including telecom (21%). Multibillion-dollar drugs hang on the outcome
of patent examiners' decisions.
So I look at all this and lots more besides. (I haven't even started on the
Russell rebalancing, which ought to be my next topic of discussion.) I think of
my mutual fund-manager friends who say, "We have to own 60 stocks, and
there's always some stock going up."
They're right. There's always some stock going up (if you can find it), and an
aging society is making the tide flow in biotech's direction for decades to
come. But when the tide's flowing out, however briefly, it's a lot harder to find a
rising boat.
Where do we go from here? Biotech was down most of last week after having
been overbought at the end of the June quarter. It's probably due for a bounce.
It has to test some trend line or another, a huge number of which have been
broken. But after a little bounce, I think it's in the lap of the market gods. I'm
guessing they'll take biotech down a PEG.
I've had some fascinating emails from readers in recent weeks. One thoughtful
fellow emailed me to ask if Amgen (AMGN:Nasdaq - news - commentary) is
making a big, fat rounded-distribution top from January 2000. I'm no expert on
such things, but I find it interesting that the stock is playing footsie with a
trend line that's been in place for more than two years. Amgen's a solid
company, but earnings grew 9% last year. I don't think they'll grow much
faster this year, which could explain what that reader sees. |
