A bubble in the biotech sector?

US biotechnology stocks have hit turbulence. The Nasdaq Biotechnology index has slid by 10% from its July peak. Since the March 2009 low, it has risen almost sevenfold, compared to a fourfold increase in the Nasdaq Composite index. In recent years, “growth-starved investors” have piled into the sector, happily paying top dollar for impressive sales growth, says Charley Grant in The Wall Street Journal.

In the second quarter, for instance, the top five biotechs by market value managed to grow combined sales by a total of 31% year-on-year. The overall stockmarket, as measured by the S&P 500, grew sales by just under 2%.

So as far as the bulls are concerned, high valuations are fully justified. But, as Ben Levisohn points out on barrons.com, “there comes a point when just rewards tip over into excess”. Frothy flotations are one worry. “There has been an explosion of low-quality” initial public offerings, says Matarin Capital’s Ralph Coutant. “It feels quite bubbly.”

Furthermore, the Nasdaq Biotechnology index is on a price/earnings ratio of 85, compared to around 30 for the Nasdaq Composite (this figure peaked at almost 200 in 2000). The biotech sector is also on an eye-watering price-to-sales ratio of almost ten.

Not everyone is rattled. Star fund manger Neil Woodford has been “outspoken about his confidence in… biotech stocks”, say Julia Faurschou and Madison Marriage in the FT. But with signs of growth slowing at the bigger biotechs, making valuations harder to justify, fears of a correction seem likely to spread.

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