iShares NASDAQ Biotechnology Index (ETF) (IBB) has been up about 14 percent thus far into the year after losing 21.6 percent in 2016. As the din surrounding the U.S. presidential election settles and the drug price gouging issue taking a back seat, the focus is back on the fundamentals of the biotech sector.
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Sitting At Undervalued Levels
Against this backdrop, Oppenheimer issued a note on Monday, expressing optimism on the entire biotech sector. The firm believes the sector is at undervalued levels. Accordingly, the firm is of the view that the group appears positioned for a positive reversal based on valuation and relative performance for the past two years.
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A Valuation Metric Confirms Undervaluation
Clarifying the firm's stance, analyst Leah Rush Cann noted that the actual-PEG for the biotech group is 2.33 times, which is 1.71 times lower than the calculated-PEG for the group of 3.99 times.
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For the uninitiated, price-earnings growth ratio is a valuation measure for finding the relative trade-off between the price of a stock, the earnings generated per share and the company's expected growth. Mathematically, PEG = P/E ratio/annual earnings per share growth. A PEG ratio less than 1 is considered to be of good value. It will help to determine if a high-growth stock is undervalued.
History Proves It Too
Oppenheimer said based on its analysis of data starting in 1998 that biotech group has never underperformed the S&P 500 for more than two consecutive years. However, in both 2015 and 2016, the sector has underperformed the broader gauge.
The firm also sees a strong correlation between anticipated relative earnings growth of the biotech group to the S&P 500 Index and biotech group outperformance. The firm noted that the biotech group has lower estimated earnings growth than that of the S&P 500.
3 Sources Oppenheimer Views Will Contribute To Relative Earnings Growth
- Expectations increasing for the largest biotech companies' organic earnings growth.
- Acquisition of late-stage clinical companies by the largest companies.
- Late-stage clinical companies introducing their first wave of new products and becoming profitable and contributing to earnings growth of the biotech sector.
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