MW Biotech stocks have been hit by 'DOGE' and other fears. Why they're a great value now.

By Michael Brush

Investors' deep pessimism is actually bullish, and less regulatory constraint could fuel new drug approval and M&A

Biotech is one of the U.S. stock market's most unloved sectors. But several indicators suggest that a bottom in sentiment could be near, and that's normally a good time to buy. Here are the signs that sentiment may be near an extreme low.

1. Small-cap and midcap (smid-cap) biotech stocks recently traded at an enterprise-value to cash ratio of 1.2, according to biotech analyst Michael Yee at Jefferies. Historically, this group trades at three times cash. Enterprise value is market-cap plus debt, minus cash. "Biotech looks inexpensive at these levels," Yee said.

2. The number of smid-cap biotech companies with market caps at or below their cash levels (a negative EV) was recently at an eight-year high, or 23%.

3. Mutual funds and generalist investor exposure to biotech was recently near extreme lows, according to a Jefferies survey. This low level of exposure often marks a bottom for the group. "Everyone is positioned so negatively. That is probably a buying opportunity," Yee said.

Here is what's been troubling investors about biotech, and why these problems may not be as bad as investors think.

1. The sector might get hit by "DOGE": The Trump administration trimmed the research budget for the National Institutes of Health (NIH). But this might not be a major problem for biotech, at least in the near term. "That affects mostly academic or early-stage research," Yee said in a recent interview. "We do not believe that NIH funding cuts directly impact medium-term outcomes in biotech."

Potential personnel cutbacks at the U.S. Food and Drug Administration also seem troubling. But maybe not. The retirement buyout offers for government employees exclude FDA staff who review drug approvals. "So far, the FDA cuts have been related to medical technology and not in crucial drug regulatory roles," Yee said. He added that several companies have recently told him they've noticed no notable changes or delays at the FDA.

2. RFK Jr. might run rampant: This remains a fear, but probably won't be a problem. Now that Robert F. Kennedy Jr. is the head of the U.S. Department of Health and Human Services, it will continue to become clear he's more focused on food safety and improving diets as a way to make Americans healthier - a plus for biotech.

3. Draconian price controls might kick in: Citizens in many countries pay far less for the same drugs than people in the U.S. "International price benchmarking" would attempt to level the playing field. Morningstar Research Services biopharma analyst Karen Andersen put the odds of this happening at below 10%. "I have a hard time seeing Republicans getting on board with this," Andersen said in a recent interview. The Trump administration might focus more on pharmacy-benefits managers, which get preferential rebates from suppliers without fully passing them on to patients.

Catalysts for growth

Here are the catalysts that might turn the group around.

1. M&A boost: Big biopharma companies have dozens of blockbuster drugs rolling off patent. They'll be shopping for biotech companies to buy to replenish their pipelines, and they have the cash. Pfizer Inc. $(PFE)$ recently said it has $10 billion earmarked for acquisitions. Now that the Federal Trade Commission $(FTC.UK)$ is in Republican hands, expect it to challenge fewer deals and to allow more biotech buyouts. This will attract investor interest.

2. Declining Treasury yields: Biopharma stocks trade inversely to the 10-year U.S. Treasury BX:TMUBMUSD10Y yield. That's because the 10-year yield is the discount rate in biotech net-present-value $(NPV)$ models. When yields fall, NPVs rise. The 10-year yield could decline to near 3%, according to economist Jim Paulsen of Paulsen Perspectives, as U.S. growth slows due to pressures from a strong U.S. dollar (DX00), declining money supply growth and less fiscal stimulus. This will benefit biopharma-company valuations.

3. A bullish U.S. government report: The Senate's National Security Commission on Emerging Biotechnology is expected to release a report on April 7 describing biopharma as critical for national security, with recommendations on how to promote drug development and domestic manufacturing.

Insider buying

A less-risky approach to biotech is to invest in large-cap biopharma stocks. These two companies saw corporate insiders recently buying stock.

Pfizer Inc. $(PFE.AU)$: Pfizer's size and strong balance sheet give it an edge in drug development, said Morningstar's Andersen. Andersen assigned Pfizer a wide moat, and a four-star rating out of five. Pfizer is launching several potential blockbusters in cancer and immunology. Data on Pfizer's obesity-drug candidate danuglipron in the first quarter could move the stock. A Pfizer director recently bought $500,000 worth of the stock at $25.65. Pfizer pays a 6.6% yield.

Merck & Co. Inc. $(MRK)$: Revenue from Merck's $(MRK.UK)$ blockbuster cancer drug Keytruda grew 21%, driving 7% overall sales growth. But Merck's stock fell after earnings because it paused shipment of its HPV vaccine Gardasil to China due to weak demand.

Merck has a pipeline of scores of potential drugs in late-stage development. Andersen singled out Winrevair for pulmonary arterial hypertension, zilovertamab vedotin for cancer, and enlicitide decanoate (MK-0616) for high-cholesterol as potential blockbusters. Two Merck directors collectively bought $1.6 million worth of stock recently at around $85.50 a share. Andersen gave Merck a four-star Morningstar rating and a wide moat. Merck pays a 3.9% yield.

Big doings in small- and midcap biotech stocks

For greater potential upside, consider earlier-stage smid-cap biotech names. Small- and midcap biotech stocks are riskier, but have been hardest hit in the sector's decline. "Smid-cap biotech looks very cheap compared with historical levels," Yee said.

Yee singled out Denali Therapeutics Inc. (DNLI), in part because it intends to file soon with the FDA for approval of its DNL310 therapy for Hunter syndrome, a rare genetic disorder. Denali could see approval for this drug by the end of the year, which would be a significant catalyst for the stock.

Also consider potential M&A targets. Jefferies singled out Structure Therapeutics Inc. $(GPCR)$, Insmed Inc. (INSM) and SpringWorks Therapeutics Inc. $(SWTX)$

Another biotech stock worth watching is Biohaven Ltd. $(BHVN)$ because of recent insider buying. A company director has purchased $2 million worth of the stock since late December in the $31-$36 range.

For the biotech sector to improve, its companies need to step up their game. Just 37% of biotech companies reported successful Phase II and Phase III trials in the first quarter, according to Jefferies. That's abysmally low. At least that was better than the 33%-35% hit rate in the third and fourth quarters of last year. Small gains, but better than nothing.

Michael Brush is a columnist for MarketWatch. At the time of publication, Brush owned PFE, MRK and BHVN. Brush has suggested PFE, MRK and BHVN in his stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks

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-Michael Brush

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March 27, 2025 07:40 ET (11:40 GMT)

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