Mixed Messages on Biotech Sector with Strong Fundamentals, but Overvalued Currently

The current health crisis has created a lot of buzz around the biotech sector as several companies from the sector are working on potential vaccines against the COVID-19 virus. That buzz has created somewhat of a mixed message for the sector as a whole. Many of the companies are overvalued at this time, but the fundamentals of many are really good.

I looked at the SPDR S&P Biotech ETF (NYSE: XBI) and its components. First, I looked at the chart of the ETF itself and saw the huge bounce off of the March low—moving from the $65 area to over $110 in approximately three months. As impressive as the move is, it is also troubling for someone like me that has a hard time buying stocks or ETFs when they are overbought.

After looking at the chart and the move the XBI has made, I started looking at the individual companies and their fundamental ratings along with the scorecard grades from Tickeron. What I found there was pretty impressive.

Of the 85 components in the XBI, 41 are rated as a “strong buy” and 17 are rated as a “buy”. There are seven “hold” ratings, eight “sell” ratings, and 10 “strong sell” ratings. There were also two that didn’t have a rating on the scorecard. I found it to be a really good sign for the long-term prospects of the sector with almost 70% of the ratings coming in at a buy or better. Keep in mind these ratings are strictly based on artificial intelligence, they aren’t the same thing as analysts’ ratings where human opinions are taken in to account.

The problem with the components is that so many are overvalued at this time. Of the 85 stocks in the fund, 45 are “overvalued”, 29 are “fairly valued”, and only 11 are “undervalued”.

The biotechnology industry involves genetic or protein engineering. The goal is to produce medicines or therapies for treating and preventing ailments. The industry also provides crucial ingredients for diagnostics. This multi-billion dollar industry is heavily focused on research and development.  Companies are continuously attempting to come up with cutting-edge solutions for health. New discoveries for the treatment of diseases provide growth opportunities for the companies. However, discoveries must pass regulatory approval from the U.S. Food and Drug Administration (FDA) before they can make it to markets.

Some of the most notable companies in the group are Amgen Inc. (NASDAQ:AMGN), Gilead Sciences, Inc. (NASDAQ:GILD), Regeneron Pharmaceuticals, Inc. (NASDAQ:REGN), Illumina Inc (NASDAQ:ILMN), Biogen Inc (NASDAQ:BIIB), Alexion Pharmaceuticals Inc. (NASDAQ:ALXN), Moderna Inc (NASDAQ:MRNA), Incyte Corp. (NASDAQ:INCY), Exact Sciences Corp. (NASDAQ:EXAS), and Sarepta Therapeutics Inc (NASDAQ:SRPT).

Of those notable companies, only Amgen falls in to the undervalued category at this time. Exact Sciences is fairly valued and all the rest of those notable companies are in the overvalued category at this time.

What all of this suggest to me is that the long-term prospects for the XBI and the biotech sector as a whole are really good. But investors might want to wait for a pullback before jumping in.

One particular technical indicator that jumped out at me was the RSI indicator. Over the last three weeks or so, 36 of the stocks in the XBI have received a signal from this indicator and only four of those 36 were bullish signals with good odds of success. There was one bearish signal that didn’t have good odds of success, but there were 31 bearish signals where the odds of success were at 60% or better. 

Given all of this information, I can see making a bullish trade on the biotech sector if the stocks as a whole see a little pullback. If enough of the stocks go through a little downturn, it should reduce the number of stocks that are overvalued. Such a move would give investors a chance to enter a trade without buying when the indicators are in overbought territory.