From an industry perspective, biotech occupies a unique hybrid position. It’s both a tech-like sector, offering secular growth potential, and a health-care sector, with corresponding defensive characteristics.
That defensive position came under attack in 2015 as political rhetoric from both sides zeroed in on perceived unfair drug pricing. Nonetheless, there are two factors worth noting regarding biotech that may make this a good entry point for investors:
1. It is under-owned and undervalued: Historically, biotech has traded off fundamental drivers: drug pipelines, product growth, mergers and acquisitions activity, and patent protection. However, as the 2015 political imbroglio increased drug price uncertainty, investors pulled money broadly out of health care.
That shift in sentiment has made current valuations more attractive. Over that past 20 years, the price-to-earnings ratio of the Nasdaq Biotechnology Index has averaged 2.3 times the S&P 500 P/E ratio; today, the current ratio is mere 1.3x, a 54 percent discount to its 20-year average (according to Thomson Reuters, as of Sept. 26, 2017.)
2. Long-term drivers are intact: Drug pipelines are notoriously challenging to predict over the short term, given the deep level of medical knowledge required, clinical testing and regulatory review. However, two trends appear supportive over the long-term. First, advances in computational biology, bioinformatics and artificial intelligence are permanent features helping reduce the time and cost of drug development. Second, approval rates by the U.S. Food and Drug Administration have steadily risen over the past two decades, climbing from 23 percent in 1994 to 89 percent and 77 percent in 2014 and 2015, respectively. Biotech’s historical drivers currently appear intact, making it one of the rare sectors that enjoys long-term growth potential at a reasonable price.