Last time we got together we talked about how the S&P 500 passed 2000. And that even though it’s up 200% from 2009 lows, most of the world didn’t notice.
That confirmed our multi-year thesis that stocks will go higher until the masses come back. When they do, history says there will be a euphoric, blow-off bubble top. That still hasn’t happened yet.
We also got the latest bit of biotech news. It too confirmed another major thesis that we’re in the middle of a multi-year biotech boom. And that’s why I’m still recommending biotech stocks despite the fact they’re sitting at multi-year highs.
Think that’s a bit crazy? You’re not alone. So here’s an explanation of the big news and why I’m more confident than ever biotech stocks will continue to soar.
Lighting the Fuse
One of the key drivers of the biotech is the “patent cliff.”
The patent cliff is the problem faced by big drug companies as the patents on their cash cow drugs expire.
It’s a situation with two parts.
The first part is where where a lot of major blockbuster drugs that are going “off patent.”
Once the patent expires on a drug, generic drugmakers are allowed to make and sell the drug. And generic generic drugmakers don’t have all the research and development costs. So they can and do charge a fraction of the price for the generic version of the drug.
This cuts deeply into the prices of drugs companies can charge for them and their margins and revenues tend to take a big hit when a drug’s patent expires.
The chart below shows some of the best-selling drugs in the world are about to - or already have - fallen over the patent cliff:
There are some big selling drugs in the table. And there are many more of them too.
Frankly, a lot of those companies aren’t prepared for the effects of this yet.
Look Abbott Laboratories (ABT) and it’s $8.2 billion-per-year-in-sales Humira.
Abbott is on pace to post about $21 billion this year in revenues. Humira makes up a huge part of that. And when Humira’s patent expires, sales will likely fall off a cliff.
If and when they do, Abbott’s share price probably won’t be too far behind.
But all that’s just half the problem. The other half of the patent cliff is just as important.
Basically, the big drug companies have been cutting back on research and development spending for years. And they have very few new drugs in their pipeline.
So you have patents expiring and new drug revenues in sharp decline. That’s the patent cliff. And there is only one solution.
As a result of all this, big drug companies must buy smaller biotech companies.
Under our mega-biotech bull market thesis, big drug companies will be buying them at steadily higher and higher prices for a long time to come.
A few days ago we saw exactly this situation play out once again in real time.
Recently Swiss drug giant Roche (RHHBY) made an offer to buy out InterMune (ITMN) for around $8 billion.
Intermune’s main drug is a respiratory treatment that’s still awaiting FDA approval. Once approved, it is expected to generate about $2 billion per year in sales.
The company also has some other drugs with more potential, but they’re still in testing phases. And they are not nearly the “sure thing” Roche is shelling out billions of dollars for now.
But the key part of this story is how quickly all this has happened.
Not long ago Intermune was a high-potential biotech company. It had share price stuck between $10 and $15 per share and a total market value of around $1 billion.
Just about six months later and after some success with it’s first major drug candidate, Intermune is part of a major acquisition and more than $70 per share.
That is all directly related to the patent cliff. It’s only going to get bigger and faster in the next few months and years. And it’s going to make a lot of biotech investors fortunes in the process.
Keep it Simple: Risk and Reward
Of course, the biotech rising tide will lift a lot of boats. But you should focus on the boats with the most rising to do.
After all, investing in biotech stocks is no different than any other sector.
Expensive stocks with high expectations for their future prospects that everyone from most investors to Wall Street pros feel comfortable buying pose the biggest risks.
They may deliver on their promises. They may go up a bit too.
But when they don’t they can be very costly very quickly.
Cheap stocks are exactly opposite.
Most cheap investments are available when companies are in a tough spot, expectations are low, and few investors are interested.
They may continue to struggle, but most of the poor performance and meager future expectations are priced into their shares. Any good news usually results in sharp rises in share prices.
It’s all risk and reward. Cheap stocks offer less risk and much bigger rewards. Expensive stocks carry big risk for much lower potential rewards.
The rest of the investment world can fret over every 4% swing in a sector.
When you buy cheap enough, whether its biotech stocks or real estate or anything else, you don’t have to worry about every market swing because you know the odds of success are greatly in your favor.