Lurking unseen in the background – far from the madding crowd of large cap investors — has been an enormous bull market in biotechnology. The Thomson Reuters U.S. Biotech & Medical Research Index (which may need a catchy acronym) has tripled since Jan. 1, 2010. We put the sector under the microscope.
Biotechnology has always been a curious beast – rarely driven by valuation, often driven purely by sentiment, insider transactions or, from time to time, M&A activity.
Leaving the S&P 500 in the dust
The chart above shows the stunning outperformance of the biotechnology sector (dark green line) in recent years, versus the relatively pedestrian (yet still stellar) performance of the S&P 500 (light green line). Here, one can truly see the effects of a mature bull market on a less well-known market segment (can you name five biotech stocks?). Indeed, one can see from the screenshot below how few of these firms are well-known to the average investor.
However, the shorts are interested
One group of investors that has sat up and noticed an opportunity is the long/short hedge fund crowd – with a remarkable number of biotechnology stocks currently featured on the tails of the distribution for short interest – and not the good tail! Twenty-five of the 50 stocks in the list are in the bottom quintile for U.S. short interest — i.e. 50% of biotech firms are in the bottom 20% – you don’t need Matlab to figure out that’s a little unusual.
A very mixed group
From the screenshot (from Datastream Professional) you can see that there’s little to suggest a theme to the shorts, aside from their membership in this industry and, in the view of StarMine’s Relative Valuation model, some pretty unappealing valuations. Other factors are mixed — analyst revisions are not overly negative, earnings quality ranges from feast to famine and some of the stocks that are heavily shorted are up hundreds of percent over the last year, while others haven’t moved much at all.
StarMine’s research has indicated that there is a positive spread in owning the stocks with the lowest short interest (for more information request the white paper) and shorting those with high levels of short interest – in other words using short interest does generate alpha. With both mainstream and biotech indices hovering near current highs, the whiff of panic in emerging markets and professional investors starting to get the scent of blood – it would be a bold investor indeed who didn’t wonder whether it’s time to take the money and run.
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