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Can anyone explain why some analysts recommend companies in the biopharmacy sector as a "buy" even though they have high R&D costs and no real profit?

I followed three companies and I see the same story. The only positive number is income, and only in one case does it cover expenses after net borrowing. For the next four in a row, the net income the net income is below zero.

Why are these companies a buy?

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    Well this is the link: biz.yahoo.com/ic/515.html Where the first two symbols is easy to navigate and see the numbers. Ziopharm and Oragenics grabed my interest. – hephestos May 26 '13 at 19:48
  • I wouldn't take an analyst's opinion, look at the charts - a picture says 1000 words. – Victor May 26 '13 at 20:48
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    The first group shown in the page you linked was for the top movers of the past week. These aren't recommendations, just the highest percent change in price. – JTP - Apologise to Monica May 26 '13 at 23:40
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    @hephestos I edited your question to make it a bit more clear, since I think this is an important question because it raises the general issue in fundamental analysis of why analysts would recommend stock(s) that at first glance, doesn't seem to make any profit. – John Bensin May 27 '13 at 0:00
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    @Editors, thank you for the corrections.I am not native speaker. Forgive me for any mistakes. – hephestos May 27 '13 at 4:04
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The biotechnology sector as a whole is a popular buy recommendation among some analysts these days for a few reasons.

  1. Some analysts feel that the high costs in R&D, even without much profit, are a positive sign for growth because it means a company is working towards finding the next "blockbuster drug" or the next class of such drugs. There haven't been many new classes of blockbuster drugs since the development of SSRI's and statins, and many of the new drugs that have been developed have been tweaks to existing classes of drugs. Some analysts feel that "it's about time" for a new class of blockbuster drugs to hit the market. A new blockbuster drug means significant profits for the company that develops it; a new class of blockbuster drugs means significant profits for the whole industry.

  2. Since about 2009, the Food and Drug Administration has been more lenient in its approval of new drugs. This wave of new approvals has reduced R&D costs for companies because they don't need to go back to the lab or earlier phases of clinical trials and continually tweak their drugs in order to gain approval. This has also made some analysts optimistic.

  3. Genetic engineering is considered an up-and-coming field with potentially significant applications to the pharmaceutical industry. Advances in this field may increase profits for the pharm industry, but since biotech companies are often the ones producing the engineering equipment, research, etc. such advances could be a major source of revenue for the entire biotech industry.

  4. In the US and in the developed world as a whole, the elderly population is growing, and since people consume more medicine as they grow older, this could lead to higher profits for companies involved in the production of pharmaceuticals (which includes biotech companies, of course) in the long run.

  5. In the US, the passage of the Patient Protection and Affordable Care Act expanded insurance coverage, which gives more people the means to afford pharmaceuticals. Also, in general, people consume more healthcare services when they have insurance (this is called moral hazard), so some analysts expect that the expansion of insurance coverage will only lead to more profits for the pharmaceutical industry and biotechnology firms in general.

  6. The global food crisis. As the climate changes, companies like Monsanto, which use various forms of genetic engineering to produce crop strains that can survive in increasingly hostile environments, look more and more appealing to places that need crops designed to grow in such environments. Any methods that could increase yields look increasingly popular, and biotechnology companies often market such methods. (As a side note, I know Monsanto is a contentious example, and there are a lot of misconceptions about "genetically modified food" and the genetic engineering methods they do, so I won't get into a debate about that).

  7. In general, technology is a popular subject right now. I've read analyst reports (from analysts that clearly don't follow the biotech sector) that base their forecasts for the biotech sector on the activities of companies like Dell, Zynga, HP, LinkedIn, Facebook, etc. Clearly, it's problematic when an analyst sees the word "technology" and automatically assumes that the biotech sector is responsive to the same factors as social media firms, hardware manufacturers, etc. This isn't to say that the biotech sector is completely isolated from this, but when I read a report that talks about Facebook's IPO being bad news for companies like Gilead Sciences without mentioning upcoming FDA decisions about Gilead's products or any biotech-specific factors, I'm not convinced the analyst has performed due diligence.

I keep using the phrase "some analysts" because I want to stress that the opinions stated above aren't universal. Although they're popular, not everyone is so optimistic. Also, I don't want you to see these reasons and think that I'm making a buy recommendation, because I'm not. I'm not making a recommendation one way or another.

I'm happy to clarify my answer too; I follow the biotechnology sector extensively. If you want to get a rough feel for the daily movements of the sector as a whole, a good place to start is IBB, the iShares Nasdaq Biotechnology Index Fund. The four largest holdings are Regeneron, Gilead Sciences, Amgen, and Celgene, which are all big players in the industry (obviously). These are a little different from the big name pharma companies like Pfizer, Merck, Novartis, etc. but they're still considered pharma companies.

It's also worthwhile to follow the FDA press announcements. By the time the news is published there, it's probably already leaked or known to people in the industry (the biotech/pharm sectors are rife with accusations of insider trading), so you might not find trading opportunities, but it's important to get familiar with the information the releases contain if you want to know more about the industry. Volatility trades are always popular trades around FDA drug approvals.

  • John, thank you for your interest. It is very informative anwer. Thank you for the links. – hephestos May 27 '13 at 4:12
  • off course it seems to be the best answer. I just wanted to give more time. In any case many thanks – hephestos Jun 2 '13 at 12:02
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Companies in their earliest stages will likely not have profits but do have the potential for profits. Thus, there can be those that choose to invest in companies that require capital to stay in business that have the potential to make money.

Venture Capital would be the concept here that goes along with John Bensin's points that would be useful background material. For years, Amazon.com lost money particularly for its first 6 years though it has survived and taken off at times.

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Most likely because they don't know what they're talking about.

They all have a belief without evidence that information set X is internalised into the price but information set Y is not. If there is some stock characteristic, call it y, that belongs to set Y, then that moves the gauge towards a "buy" recommendation.

However, the issue is that no evidence has been used to determine the constituents of X and Y, or even whether Y exists in any non-trivial sense.

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