Look Behind the Numbers…


A recent article from FierceBiotech discusses the last year’s share price recovery of CRO stocks in the US. It refers to a panel at the recent Partnerships in Clinical Trials conference in Orlando:

Over the past year, said John Kreger, an analyst with William Blair & Co., CRO stocks surged as optimism about the economic recovery-along with the prospects for new drug research-began to spread. Interestingly, he added, CROs focused on preclinical work saw their shares jump 42 percent compared to a 33 percent increase for CROs dedicated to the clinical arena – even though the clinical work has traditionally outperformed preclinical. Kreger thinks the unusual balance was triggered by investors’ belief that a recovery will initially tilt in favor of earlier-stage work as more new programs are launched.

 

 

Now, on first look this sounds very impressive – and in normal circumstances it would be. But what  the article fails to mention is that over the same period, the broader indices did the same or better. In the 12 months preceding the date of the article, the S&P 500 had recovered over 40% (click on figure below); NASDAQ had performed even better, returning a heady 50% to investors brave enough to get into the market at a time of serious pessimism. So, you could have used all your industry specific knowledge and contacts (assuming you had them in the CRO space), perform detailed fundamental analysis, accurately assess the forward prospects of the industry were about to turn good, and place your bets a year ago figuring that the CROs were due a price run-up. Or, you could have bought the index, sit back, and done just as well or better.

 

   SP500April2009-2010

Upon closer inspection, we find something else interesting. When looking at a basket of the leading quoted CROs, one notices that the price variation and performance over 12 months is huge. Paraxel  (NASDAQ: PRXL) returned around 170%, Covance (NYSE: CVD) over 60%, Charles River Laboratories (NYSE: CRL) over 50%, and Pharmaceutical Product Development (NASDAQ: PPDI) around 35%. Albany Molecular Research (NASDAQ: AMRI) was actually negative with a return of -10%. So, this further suggests that looking at the simple headline numbers discussed in the article can be quite misleading. (As an aside, the run-ups in price have created somewhat richly valued CRO stocks, pricing in perfection, and setting up investors for a fall. This has happened this week on a broader market downturn – CRL is down 15% in the last week alone).

This is not to say that one should just invest in an index fund and be done (though there is much to commend that approach if you do not have the time, energy or inclination to perform thoughtful stock research). Pricing inefficiencies can and do exist – markets do tend to be efficient, but not perfectly so. The important take-away is to assess such opportunities in context – what else is going on beyond the immediate stocks concerned? And is there better value elsewhere?

Part of the analyst industry’s handicap is that they are specialists in just one sector. But if one only looks for value in a certain sector (or worse, sub-sector) then how can you develop any meaningful context by which to frame decisions? Such comparison doesn’t have to take a long time or other industry specific knowledge – rather a sanity check to see how well businesses are performing in other sectors, relative to their valuations.

In investing, as with many other things, not all is what it first seems. Look behind the numbers, then check to see what’s going on elsewhere.

This post is by Raman Minhas. He is CEO of ATPBio, a consultancy firm providing strategic insight and transaction support to the life sciences industry.

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