Small Cap Biotechs Look Attractive; Here's How I Find the Sector's Winners

Small cap biotechnology stocks are some of my favorite investments. The innovations and cures you can find companies working on, and the rocketing of their stock prices once approvals are announced, are fascinating – and potentially very profitable.

It’s not a place for the timid, of course, because biotechs are also among the most volatile stocks. But there are ways to stay on the safer side and lower your potential for losses — and these stocks could soon have a catalyst to help propel them higher again.

You see, last year the sector lost momentum, dropping 15.4% in 2016 after gaining 64.7% in the two years prior. It wasn’t because of poor fundamentals as much as it was political risk. Then-presidential candidate Hillary Clinton sent out a Tweet regarding drug company “price gouging,” and the president-to-be didn’t do much to alleviate those concerns with Tweets of his own on the same topic.

But that’s ancient history as the anti-drug rhetoric is settling down post-election. Plus, some kind of “TrumpCare” program is likely to replace the Affordable Care Act before long. That may help encourage investors to get back into biotechs because it will eliminate uncertainty about health care policy.

Meanwhile, fundamentals are favorable and supportive of an upside reversal. For one thing, price-to-earnings ratios for those biotechs that are profitable are around 14. That’s near a 10-year low and well below the S&P 500’s pharmaceutical valuations. For another thing, earnings are expected to grow as much as 10% to 15%, making biotechs one of the market’s fastest-growing sectors. Also don’t forget that when stocks are undervalued and earnings are strong, it prompts merger and acquisition activity – another upside catalyst for the sector.

Still, like any other group of stocks that are worth owning, biotechs take work to research and understand. There are more land mines out there than there are quality, investable companies. So I need to look at each potential investment to find out what cures they’re working on, what the addressable need is, who their competitors are, what stage of development they’re in, what stage of testing and approval they’re in, how their pipeline looks, and the management team’s prior success in developing, getting approval, and commercializing drugs.

In other words, there’s a lot to do! So minimizing the starting point to a handful of stocks is imperative to being able to make an investment in short order. That’s where the Weiss Ratings Stock Screeners come in handy (You can access them as a Weiss Platinum member here; If you’re not a member yet, click here to get signed up).

I recently ran a Screener to illustrate how many stocks fall into the “Pharmaceuticals, Biotechnology and Life Sciences” industry group. It’s a hefty 1,003! So to narrow that down further, I looked for U.S.-based companies that were also sufficiently liquid — meaning they had to have at least 50,000 shares in average trading volume and a market capitalization of at least $50 million. I also wanted to see positive returns over multiple time periods – 1-month, 1-year, and year-to-date.

This particular screen narrowed that list down to 38 names, some of which you can see here. That allows me to then take a closer look at the aforementioned fundamentals, as well as analyze the technicals, to find final recommendations and favorable entry points for my Top Stocks Under $10 publication.

Bottom line: With the roll out of some kind of “TrumpCare” expected soon, watch the market reaction in Healthcare stocks. If biotechs can regain momentum, the upside move could be fierce, and not something you want to miss, given favorable industry fundamentals.

Best wishes,

Mandeep

Small Cap Edition, By Mandeep Rai, Senior Analyst Mandeep Rai has more than 15 years of investing experience, working as both a stock and credit analyst. At Weiss Ratings, he researches and evaluates financial and economic themes, and makes decisions on when to buy or sell specific shares for the Top Stocks Under $10 portfolio.