You Almost Have To Be Crazy to Invest In These Stocks
Posted: February 22, 2018
By John Dorfman
February 19, 2018 – Hope stocks. Fads. Castles in the sky.
Those are the words I think of when I see a stock that sells for 100 times revenue or more. In my view, you almost have to be crazy to invest in them.
Over the years, a typical stock has usually sold for about 1.4 times revenue. In today’s rich market the prevailing ratio is 2.25. So, we’re talking about stocks that sell for 44 times prevailing valuations, which are themselves rich.
The vast majority of these stocks are biotech stocks, and proponents argue that they are worth the inflated multiples. These companies are searching for treatments for cancer, heart disease, multiple sclerosis, or other diseases that terribly afflict humankind.
Why shouldn’t they sell for sky-high multiples of revenue? After all, if the companies find what they are looking for, the sky is the limit on profits. Furthermore, they say, it’s unfair to use standard ratios to judge companies that are just getting going.
To this I say: Baloney. These stocks are so far ahead of themselves they could fall over – and many do.
The record bears out my skepticism. Over the years, I have written about 64 stocks that sell for 100 times revenue. Forty-eight of them have declined. Another eight have risen but less than the Standard & Poor’s 500 Index. Only eight have beaten the index.
What’s more, the magnitude of the declines has been mountainous. On average, these stocks have dropped 31.4% in twelve months, while the S&P 500 has risen 9.3%.
My last column on this subject, published in February 2017, fit the pattern. Tesaro Inc., a biotech firm working on cancer drugs, dropped 68%. Acadia Pharmaceuticals Inc. fell 21%. Liberty Broadband Corp. (LBRDK) rose 6.6%, but that fell far short of the 17.8% gain in the S&P 500.
Keep in mind: The track record for my column recommendations is theoretical and doesn’t reflect actual trades, trading costs or taxes. These results shouldn’t be confused with the performance of portfolios I manage for clients. And past performance doesn’t predict future results.
Here are a few stocks that sell for more than 100 times revenue now.
Alnylam Pharmaceuticals Inc. (ALNY) is a biotech firm based in Cambridge, Massachusetts. The company is working on techniques that would, in effect, block out the effect of certain harmful genes.
The first application would probably be to treat amyloidosis, a genetic disease that can cause severe pain, neurological problems and heart failure. Alnylam believes that its techniques can be applied to other conditions as well.
Alnylam’s revenue last year was $89.9 million, mostly in payments from potential partners. The market value of its stock is $12.2 billion, or 125 times its revenue.
Could Alnylam succeed? Sure, and I hope it does. But investing is to a large extent a game of playing the odds. And the odds don’t favor any company that sells for such a revenue multiple.
In December 2016, when Alnylam stock sold for about $42, I called it an “interesting speculation.” Now that the stock fetches about $123, I say: Stay away.
The charmingly named Blue Biotech Inc. (BLUE) is also a biotech firm based in Cambridge, and also focuses on gene therapy for neurological disorders. Its revenue last year was just short of $40 million. The market value of its stock is $10.5 billion.
That works out to a price/revenue ratio of 272.
Of 19 analysts who follow Blue Biotech, 11 rate it a “buy.” One of the dissenters is Leerink Partners, which has a good reputation for health-care analysis. According to Bloomberg LP, the Leerink analyst, Michael Schmidt, recommended Blue Biotech all the way from $67 to $194, but he got off the train in January.
Adamas Pharmaceuticals Inc. (ADMS) of Emeryville, California, already has an approved drug on the market, Namenda. Marketed by Forest Laboratories, it treats dementia associated with Alzheimer’s disease, a widespread problem and, obviously, a huge addressable market.
Last year, Adamas’s revenue amounted to less than $1 million. Analysts think revenue will grow to about $92 million in the next two years. Investors seem to me to be jumping the gun: They already award Adamas a market value of $868 million.
The price/revenue ratio is 18,600 for the trailing twelve months, and 9 times estimates two years out. In poker terms, I think investors are trying to draw to an inside straight – not a move with good odds.
Disclosure: I have no positions long or short (for myself or clients) in the stocks discussed today.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at firstname.lastname@example.org.