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A 2,800% Biotech StrategyBy Larsen Kusick, analyst, Phase 1 InvestorMonday, August 29, 2011 "What happened is all these things were priced to perfection. When the overall market became weak, these guys were just ripped to shreds."
Last week, I spoke to a contact of mine who specializes in one of the world's most extraordinary growth industries: gene sequencing. Above, you'll find his description of the huge selloff in companies that specialize in this area of the market... Some have dropped 30%-40% in just a month.
In general terms, gene sequencing uses genetic analysis to target and treat diseases individuals are likely to get. Fifteen years ago, this technology didn't exist. But now, doctors can analyze your genes to treat diseases far earlier than ever before. They can even tell which diseases you are likely to get in the future. Depending on your genetic makeup, doctors will prescribe a treatment specifically for you.
Gene sequencing is still in the early stages of becoming common practice in hospitals and doctors' offices. Until now, researchers in white lab coats were the biggest users of the high-tech machines needed to decode a person's genetic information.
The migration of gene sequencing out of labs and into doctors' offices is as close to a "sure thing" as you can get in the risky biotech space. This analysis used to cost millions of dollars. It now costs less than $10,000. Over the next year or so, prices will reach a level where millions of people will be able to afford this technology.
A bigger market means huge profits for a select few companies over the next decade. But as you would expect from a market with such huge potential, the companies in this space are almost always expensive... and thus vulnerable to sharp selloffs.
For example, back in July 2010, I wrote bullishly on gene sequencing giant Illumina (ILMN). It produces machines and systems for gene sequencing. After I wrote about it, shares rocketed 75% in 12 months. But over the past month and a half, Illumina has plummeted 40%.
This big drop wasn't limited to Illumina. Life Technologies (LIFE) – another multibillion-dollar giant in gene sequencing – is down about 35% in the last three months. Several smaller names fell even more.
Last week, my contact noted how the selloff was caused by the high expectations for these companies. For example, analysts were predicting Illumina's next two quarters' earnings would grow by 31% versus the same period last year. Based on the company's latest results, the growth rate will likely be below 20% – still impressive growth in today's economy.
I asked my contact if the declines mean anything for the overall gene-sequencing trend. "Absolutely not," he said. "This hasn't affected anything. We're seeing a transition in sequencing from research-only applications into clinical applications." In other words, the technology is coming to your doctor's office.
He pointed out that the biggest short-term risk in these stocks is always expectations. Analysts and investors get too excited about how fast the companies are going to grow... and they bid their valuations through the roof. The second there's a sign of slower earnings growth, they panic. That's why you see such big drops even during a multi-year uptrend for the stocks.
These kinds of pullbacks are common in hypergrowth companies. Since the start of 2003, Illumina's stock fell 35% below its previous high on seven separate occasions. Keep in mind, shares are up more than 2,800% during that span. The selloffs in this extraordinary company were buying opportunities.
Illumina is still a likely long-term winner in gene sequencing... But it's now a $5 billion company. It's had a huge run. The company has already captured about 70%-80% of the market for the "boxes" that handle gene sequencing.
Along with its larger peers, Illumina will likely see 20% growth in the gene sequencing market. But many smaller companies are growing by well over 100% annually, and their technologies are just starting to hit the market.
So for bigger gains, I'd rather use the industry-wide selloff to pick up shares of smaller companies that will benefit from this long-term boom.
Good investing,
Larsen
Further Reading:
Illumina may be down right now. But as Larsen said today, the company is still a likely long-term winner.
"We've already seen stocks in some of these companies soar," Larsen writes. "But the story isn't played out yet."
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Gold has outperformed stocks by 30% over the past three months.
The S&P 500 is still trading 5% above early-August lows.
Deutsche Bank and Royal Bank of Scotland sink to new two-year lows.
Gold miners are avoiding the market selloff... Agnico-Eagle and Yamana Gold post double-digit gains over the past month.
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