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Biotech: what went wrong?

Vertex Pharmaceuticals' headquarters in South Boston.
Dina Rudick | The Boston Globe | Getty Images
Vertex Pharmaceuticals' headquarters in South Boston.

As the first quarter comes to a close, one sector notably stands out in the negative column: biotech. The iShares NASDAQ Biotech ETF, a market-cap weighted basket of biotech stocks, is down 24 percent this year. Unlike most of the market, it never participated in the mid-February bounce.

Let's look at just the biggest names, the biotech stocks in the S&P 500. All of them have performed terribly this year:

Vertex: down 37 percent

Regeneron: down 33 percent

Alexion Pharma: down 29 percent

Biogen: down 17 percent

Celgene: down 17 percent

Gilead Sciences: down 9 percent

Amgen: down 8 percent

Pretty ugly, eh?

A host of problems beset biotech stocks in the first quarter. There were reports that some funds were using them as a source of funds to handle redemptions from shareholders. Others reduced their exposure to the sector. Momentum investors have left in droves. And the halving of the share price of Valeant late in the month was also a problem, adding to the anxiety of risk managers who had already been reducing exposure to health care.

One major overhang is drug pricing, an issue highlighted by the Valeant fiasco. Government intervention in drug prices still has a relatively small chance of succeeding, but it hangs over biotechs.

"Drug pricing is a big black box, so it's hard for investors to model that into these stocks," BTIG's biotech analyst Hartaj Singh said. "This being an election year, a lot of investors have figured it's better to take some money off the table."

To a certain extent, big biotech grew explosively in the last six years, and is now hitting some natural walls in terms of sales and earnings growth. Throw in high multiples and massive stock price run-ups over the prior six years, and you have all the makings of a major disappointment.

Let's look at those top seven Biotechs above. As a group they have seen a significant slowdown in both sales and earnings, according to BTIG:

Big biotech sales growth

2014: 41 percent

2015: 20 percent

2016 (est.): 5 percent

Big biotech earnings growth

2014: 50 percent

2015: 28 percent

2016 (est.): 9 percent

This is critical because if you are a general investor, and particularly a momentum investor, you look at sales and earnings momentum. Most funds do not have the staff to look at all the nerdy science that is behind these companies.

To a certain extent, these Biotechs have become victims of the law of large numbers. Their sales skyrocketed in the last few years, along with their stock price.

Look at Regeneron's sales (in millions):

2010: $459

2011: $446

2012: $1,378

2013: $2,105

2014: $2,820

2015: $4,104

2016 (est.): $5,096

It's like a rocket, straight up. And that fueled the stock price, which went from $40 or so in 2011 to more than $500 last year.

What's the next step? Bulls are arguing that the sector is set to rally because so much bad news has been priced in. Maybe, but there is no sign investors are flooding back in.

With so much investor indifference in the space, it would help to have some research breakthroughs. The AACR (American Association for Cancer Research) meeting is April 16 to 20 in New Orleans, and many companies will be presenting data.

  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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