Indexes

Biotech: The Growth Story Continues

Sparked by a more favorable regulatory environment, new cutting-edge technology, and a fresh infusion of IPO and venture capital, the Nasdaq Biotechnology Index has experienced tremendous recent growth and looks poised to continue that trend. Nasdaq Global Indexes delves into the primary drivers of the optimism around the Biotechnology market.

Aging Population

The size and scope of the Baby Boomer generation has opened an abundance of opportunities for both companies and investors alike. The first of America’s Baby Boomers, born during the period 1946 to 1964 , are going to hit their 70th year in 2016. As this generation of Americans grows older, the implications on the country’s healthcare infrastructure will be vast. The large portion of the population that the Boomer generation represents will soon have to contend with a higher incidence of health issues that often come with age, including serious diseases such as Alzheimer’s and Parkinson’s.

Fortunately, these Boomers are living in an unprecedented age of scientific discovery when it comes to the use of pharmaceuticals and other therapies to treat conditions ranging from arthritis to cancer. One recently announced planned study, focusing on a commonly used diabetes drug, even hopes to find ways of slowing the aging process itself . While this generation of retirees will require a constant ebb and flow of treatments, biotech companies are stepping up their research efforts with the goal of capitalizing on this huge market.

Drivers of Growth

A tremendous amount of innovation continues to occur in biotech, such as immunotherapy, which involves using the body’s own immune system to treat serious diseases, have helped to fuel a boom in the biotechnology sector.

As new discoveries draw investors to the sector, other factors are adding fuel to the fire behind the sector’s strong performance. The regulatory environment in particular remains very accommodating to pharma and biotech companies. The FDA approved 41 new drugs during 2014, the largest number of yearly approvals in at least a decade . According to a report issued by the FDA, “About 41% of the novel new drugs approved in 2014 (17 of 41) were approved to treat rare or ‘orphan’ diseases that affect 200,000 or fewer Americans. ” Companies are generally able to justify charging higher prices for these so-called orphan drugs, given their importance to the patient populations they serve and the high cost of associated R&D.

Innovations outside of the orphan drug category have also been on the rise. The 24 non-orphan drugs the FDA approved last year are now being marketed to treat conditions such as type 2 diabetes, melanoma, hepatitis C, late-stage non-small cell lung cancer, and a number of blood cancers .

Investor money has flowed into the space like never before, and this is evident in the performance of stocks in the sector. The Nasdaq Biotechnology Index, which tracks a number of bellwether companies in the space, returned 34.1% in 2014, far outpacing both the S&P 500 and corresponding Healthcare Index. Here is a chart of the performance of the indexes:

June 2015 Biotech Index Chart 1

Strong biotech performance has investors flocking to biotech-related ETPs in record numbers. Collectively, the top five largest biotech ETFs are home to over $16 billion in assets. With over $8 billion in in assets, the iShares Biotech ETF is the largest product tracking the Nasdaq Biotechnology Index.

June 2015 Biotech Index Chart 2
June 2015 Biotech Index Chart 3

Capital Market Optimism

M&A has also been a major value-driver as larger companies in the sector continue to focus on executing transactions that will expand their portfolios of marketed drugs, grow their pipelines, and complement existing business lines. During the first quarter of 2015, healthcare was the top sector for M&A with $126.5 billion in volume, according to a report issued by Dealogic. Four of the top 10 announced M&A transactions in the first quarter were healthcare-related deals . There also has been no shortage of opportunities to access capital for smaller companies with new drugs under development. The environment for equity IPOs, secondary offerings, and debt raisings continues to be favorable, with interest rates at historically low levels. Even with the prospect of the Federal Reserve raising rates later this year, financing will still be cheap relative to when the Federal Funds Target rate hit its last peak in 2006 of 5.25%. In the first three months of 2015 alone, 17 healthcare companies took advantage of the favorable financing environment and priced IPOs, raising a combined $1.78 billion. This windfall represented more than a quarter of the money raised by all IPOs during 1Q15 .

Valuations

Biotech is becoming a maturing industry with a growing number of profitable and cash-generating companies. Examining the Price-to-Earnings ratio of largest constituents of the Nasdaq Biotechnology Index, they have valuations aligned with those of traditional mature pharmaceutical companies. Although valuation metrics are similar to those of “Big Pharma,” performance metrics are not. Gilead Sciences, Biogen, and Celgene have outperformed by a wide margin over the last several years. In addition, these current multiples seem rather reasonable considering biotech names tend to exhibit greater future growth prospects when compared to more mature healthcare names.

June 2015 Biotech Index Chart 4
June 2015 Biotech Index Chart 5

Furthermore, an additional metric used to measure valuation is the Price/Earnings Growth Ratio. Popularized by legendary investor Peter Lynch, a PEG Ratio close to one indicates that a stock is more reasonably valued given its expected growth prospects. As you can see, the top constituents of the Nasdaq Biotechnology Index exhibit more favorable PEG metrics than the “big pharma” names.

June 2015 Biotech Index Chart 6

The price appreciation of biotech stocks has outpaced the broader market in recent years. In short, this is truly a historical period for this sector. Biotech names, armed with an influx of fresh capital, could be entering a golden age, leading the charge of innovation and product development essential to the well-being of a maturing population.

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Nasdaq® and NASDAQ OMX® are registered trademarks of The NASDAQ OMX Group, Inc. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither The NASDAQ OMX Group, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED. © 2015. The NASDAQ OMX Group, Inc. All Rights Reserved.

2 Source: http://www.wsj.com/articles/scientists-new-goal-growing-old-without-disease-1426542180

3 Source: http://www.fda.gov/downloads/Drugs/DevelopmentApprovalProcess/DrugInnovation/UCM430299.pdf

4 Source: http://www.fda.gov/downloads/Drugs/DevelopmentApprovalProcess/DrugInnovation/UCM430299.pdf

5 Source: http://www.fda.gov/downloads/Drugs/DevelopmentApprovalProcess/DrugInnovation/UCM430299.pdf

6 Source: https://publishing.dealogic.com/ib/DealogicGlobalMAReview1Q2015FINALMEDIA.pdf

7 Source: http://www.nasdaq.com/markets/ipos/activity.aspx?tab=pricings&month=2015-01

http://www.nasdaq.com/markets/ipos/activity.aspx?tab=pricings&month=2015-02

http://www.nasdaq.com/markets/ipos/activity.aspx?tab=pricings&month=2015-03

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.