Is P/E Compression Making Biotech a Bargin?

Is P/E Compression Making Biotech a Bargin?

For the first time in biotech history, price to earnings multiples (P/E based on next year’s projected EPS) for large cap biotechs dropped below the average P/E for the S&P 500 index. Is this a sign that biotech is cheap relative to the market or is it because earnings growth is shrinking, commanding a lower P/E ratio?

If we look at end of quarter P/E ratios (price /next 12 months of earnings) for the largest biotech therapeutic companies (AMGN, GILD, GENZ, BIIB, CELG, CEPH) over the last five years, we see a >50% drop in the P/E from above 30x to below the S&P500 average of 15x (chart 1). If this was only a readjustment to growth expectations we would see a flat PEG curve. However, the same time series that divides that P/E ratio by forward growth projections (called the PEG ratio) shows a downtrend of the PEG to below 1.0 (see chart 2 by clicking read more below).  The drop in growth expectations alone is not enough to explain the lower valuations we see in these top biotechs.

Perhaps this is a great time for generalist portfolio managers seeking “Growth At a Reasonable Price” (GARP investors) to rotate into the sector?

Note: Average growth projections for the six biotechs went from 24-25% in 2004 to near 16-18% in 2009. These six were chosen because they are all large therapeutic companies (note that the BTK has many tools or diagnostics companies that may not be direct comps) and each had established revenue at the begining of 2004, where the chart begins.

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