As Peter Lynch noted in his book “One Up on Wall Street,” it wasn’t the gold diggers that turned significant profits during the California Gold Rush. It was the people who sold pickaxes and work clothes to the miners. In other words, you turn a profit when you have a product that is selling, not when you are still in the process of finding gold.
As medical science advances in leaps and bounds, you may have seen at least one person plugging up their bionic arm for charging at a big event. The technology doesn’t come cheap, but the companies that produce shiny new biotech drugs and prosthetics, much like the miners during the gold rush, are not generating profits for the most part. In fact, many of them, such as Ekso Bionics Holdings Inc. (EKSO, Financial), have consistent negative net revenues and plummeting stocks.
The struggle to turn a profit
Ekso Bionics is a company that produces powerful advancements in medical technology, but is unable to turn a profit or boost its stock price. The biotech company creates external physical support systems, called “Exoskeletons,” which help patients through rehabilitation after severe injuries. This technology has also been adapted to increase worker productivity in high-demand physical labor jobs, especially in the military. However, since the company’s founding in 2015, it has produced a negative net income every year, as shown in the chart below. It has a GuruFocus financial strength rating of 3.2, a profitability rating of 3 and an operating margin of -167.1%.
Out of 20 stocks listed under the Biotechnology industry, only nine have a price-earnings ratio as of Oct. 14, and one of those is Neurocrine Biosciences (NBIX, Financial) at a price-earnings of 694.87. Neurocrine Biosciences focuses its research on cures for drug and disease-induced neurological endocrine disorders. Since the company’s founding in 1996, it has only generated a net income for five years, and it has an interest coverage of 0.31%. Much like Ekso, Neorocrine Biosciences is a good example of a company that focuses far more on research than profitability. The share price for this company spiked to $123.31 in 2018 due to overvaluation and grant money, but it has been dropping since then, heading towards the Graham number calculated at 5.13, as shown in the chart below.
Stocks that can benefit from new medical technology
Ossur hf (OCSE:OSSR, Financial) is a medical technology company that offers a wide range of lower-limb prosthetics and support devices. This Icelandic company was founded in 1971 and has since branched out to 25 countries in six continents. Its focus on strategic acquisitions and on developing a range of products for various budgets has aided its steady expansion, and an easy-to-use online ordering system simplifies the purchasing process. As shown in the chart below, Ossur has been able to consistently grow its revenue and net income since its initial stock listing. The company has a GuruFocus financial strength score of 6, a profitability core of 9, a price-earnings ratio of 34.36 and an operating margin of 13.86%. This high profitability is due to its focus on purchasing the research and selling the products, allowing for higher revenue creation than more research-focused companies.
For biotech, one of the few companies that has transitioned out of the research-heavy phase is Vertex Pharmaceuticals (VRTX, Financial). Vertex’s success in developing treatments for cystic fibrosis has catapulted it into profitability over the past year, and it will acquire Semma Therapeutics in the fourth quarter of 2019 for its curative cell-based treatment of type 1 diabetes. This acquisition marks a new stage for Vertex that will ramp up production and sales as it gains the funds and influence to put more products on the market under its name. In 2018, Vertex had a net income of $2.096 billion compared to $263.48 million the previous year and consistent net losses before then. As you can see in the chart below, the company’s Graham number has increased to 55.89, while the Peter Lynch fair value is unable to be calculated, indicating Vertex’s intrinsic value is skyrocketing. Once it begins sales of Semma’s type 1 diabetes treatment, the stock will likely continue to rise.
Disclosure: Author does not hold positions in any of the stocks mentioned.
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