“Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries.”
That’s what Janet Yellen, the head of the Federal Reserve, stated 11 months ago.
The warning couldn’t have been more wrong.
Since then the Nasdaq Biotechnology Index rose 54%.
Now, that’s an extreme gain for any sector in just 11 months. Probably too extreme. Almost bubbly.
But I’m not here to warn you about biotech stocks.
Frankly, our advice on biotech remains the same as it has been throughout the epic bull run in biotech and all rising stocks, let your winners ride.
I’m here to explain to you how you can still get in on the biotech bull without having to risk a lot to make a lot.
The Real Secret Behind the Biotech Bull Market
First though, we’ve got to look at a couple of factors which have propelled the run in biotech stocks.
Factors few others have even considered yet are crucially important to understanding how biotech stocks can still go much higher.
One technical factor specifically is about the stock prices really stick out to me and which I never hear about anywhere else.
It’s about what happened before this bull began. And it’s really important to understand how the run in biotech stocks appears larger and more unsustainable than it actually is.
You have to go back to the credit crisis to get it though.
When the financial world was collapsing, investors were focused on stocks which which they could ride out the crisis with. Shares in companies that were “always going to be there” were most in demand.
For example, shares in Coca-Cola (KO), Wal-Mart (WMT) and Microsoft (MSFT), which had little debt, strong brands, and consistent revenues, were the safe buys.
At the other end of the risky/safety spectrum was biotech. The antithesis of safety. Most biotech companies don’t have any revenues at all. They just have expenses. They will not survive to advance their development drugs without more money and more time.
So when the credit crisis hit, large biotech companies with drugs on the market got hit pretty hard like everything else. But the small biotech stocks were absolutely crushed. Drops of 80% to 90% were standard at the height of the crisis.
That’s the key part here.
Since the initial dive for biotech stocks was so extreme, the rebound equally as extreme.
So when biotech stocks rise 517% from their 2009 lows, it feels far greater than it is.
After all, a stock that drops 80% and then rises 500% is only up 20% overall.
We’d estimate that if we excluded the most severe parts of the credit crisis, biotech stocks are up about 200% or so.
That’s certainly a big run. But it’s not one which must end imminently or can’t still go much higher.
How to Ride the Biotech Bull Safely
All that’s why we still foresee the potential for more gains in biotech stocks.
But as you should expect, as the editor of The Cheap Investor, I see a much better way to play which delivers far greater returns with far less risk than jumping on the entire sector and hoping it all works out.
That way is to buy cheap biotech stocks.
Granted, there aren’t many cheap biotech stocks left in this market. There are very few that are down 80% or more and yet still have the potential to go much higher.
But there are some and they’re beating the overall biotech sector by a large margin.
For example, the five stocks featured in my report Top 5 Stocks to Ride the Biotech Bull are up an average of 67% each in the last six months.
Again, that’s average gains for each of them. It’s not total gains adding them all up. It’s average.
The Nasdaq Biotechnology Index is up a good-but-not-as-good 29% over the same time period.
That’s the real advantage of buying cheap biotech stocks. They’re far less risky because they’re down so much already and they’re delivering far greater gains the overall biotech sector.
Buying cheap is a win/win in any sector. At this point in the biotech bull market, it’s the only way left to really win big safely.