[Biotech stocks] are beginning to dangerously resemble the dotcom mania of the 90s.
That’s the warning from the Telegraph last week.
The timing of the warning isn’t surprising.
The Nasdaq Biotechnology Index fell 10% last week. It is only it’s fourth 10% or greater decline in the past five years.
Naturally, with the stocks already down a bit, the expectation for the short-term trend to continue indefinitely into the future. And since biotech has done so well over the years, that means the biotech party would be over.
As usual, we’re not going to respond to short-term market swings. We’ll let the data be our guide.
Is the Biotech Bubble About to Burst?
Biotech has been on an incredible run over the last few years.
In 2013, after a four year run for biotech stocks, we laid out the case why the best times were yet to come for these high-flying stocks.
We just compared what happened to biotech stocks back in 1999 to what was happening in 2013.
The similarities were obvious and signaled a major boom was about to take place.
At the time we showed Profit Alert readers this chart from the late 90s:
The circle denotes the point when biotech stocks “caught up” to the rest of the market.
This point was a major indicator of strength. And in stocks, buying and strength tends to get more buying and strength.
So when we saw same thing happen to biotech stocks back in early 2012, we knew the run had much, much potential.
Here’s the chart that shows the same crossover point in 2012:
Since then the analysis has been proved completely accurate.
Biotech stocks almost doubled between 2009 and that point in early 2012. But after they hit the crossover point, biotech stocks have more than tripled.
The move brought total gains to the sector of nearly 500% with more than a handful of exponential biotech winners.
At this point, however, even we’re getting a bit worried. Not about the recent correction in biotech stocks. But some other factors which indicate biotech stocks aren’t worth the risk.
The first problem is the fundamentals are really getting disconnected from the price.
The Nasdaq is currently trading at 2.3 times annual sales. The Nasdaq Biotechnology Index, meanwhile, trades at more than 10 times sales.
That’s rich valuations, for sure. But it’s not necessarily a sure sign a bubble has formed in biotech stocks that will imminently burst.
Another indicator is much more worrying.
As long-time Profit Alert readers know, initial public offerings (IPOs) tend to be the worst possible stocks to buy.
Of course, there are a number of exceptions. But even with those exceptions, IPOs tend to lose money over time. We’ve cited a number of studies in these pages. All have the same conclusion - don’t buy IPOs.
Biotech stocks, recently, have bucked the long-term trend in IPO performance.
According to Renaissance Capital, all biotech IPOs over the last two years are up an average of 78% from their offering price.
That’s more than triple the returns of all the other IPOs and, given how dreadful IPOs tend to perform, it’s a clear sign biotech may be overheated.
It doesn’t stop there though. Biotech stocks made up a disproportionate share of IPOs too. One in four of the 275 IPOs in 2014 were biotech stocks.
That’s a saturation-level of IPOs only a bubble-like buying spree can absorb.
Add it all up and you’ve got a bubble in biotech.