Pharmaceuticals: 1 Short, 1 Buy, 1 Strong Buy

Mohsin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Biotechnology stocks are usually valued on the potential of their pipelines, especially if there is no drug already in the market. The 'patent-cliff' has increased the investor interest in promising pipelines, improving the valuations of small biotechnology companies. The increase in FDA approvals has also positively impacted the entire healthcare sector by encouraging investors to invest more heavily in pipeline stories.

A number of biotechnology companies have benefited from this investor goodwill, but are only few which truly deserve it. An effective method of singling out over-valued investments and exploring strong pipelines is to follow insider and institutional trades. 

Short

Vertex Pharmaceuticals (NASDAQ: VRTX) is a biotechnology company involved in the discovery, development, and commercialization of small molecule drugs for serious human ailments. The company has two approved drugs and 6 compounds in various stages of clinical trials. Telaprevir is approved for patients infected with HCV (genotype 1) and ivacaflor is approved for treating cystic fibrosis. Pipeline has compounds for treatment of Cystic Fibrosis, Hepatitis C, Autoimmune Disease and Influenza.

The company posted revenues of $1.5 billion last year, but the street expected $1.2 billion in 2013 revenues. The primary reason behind this revenue decline is the lower sales of Incivek. The drugs revenues declined a mammoth 42% year over year to $205 million for the first quarter of 2013. Despite this steady revenue decline, the stock is up 65% YTD on pipeline expectations.

The market valuations of Vertex depend on the potential/expectations from its pipeline. For small biotechnology companies, insider transactions give an insight into the true potential of a pipeline. In the last six months, Vertex insiders have sold approximately 990,000 shares, reducing total insider holdings by a massive 36%. During the same period, institutions have also sold approximately 8.9 million shares, reducing institutional holdings by 4.6%. Heavy selling by insiders and institutional investors is an indication that investors should not rely too heavily on the pipeline. Falling sales and lack of insider confidences makes Vertex a decent short target.

Buy

Accelerate Diagnostics (NASDAQ: AXDX) is involved in the development and commercialization of bio-analytical measurement instruments and proprietary surface chemistry formulation. The company is working towards eradicating drug resistant organisms and hospital acquired infections. It offers the BACEEL and OTICHEM platforms for detection and coating technologies respectively.

It is currently trading near its 52-weeks high and has already appreciated 90% YTD. Insiders are also showing interest in company with Director Larry Fienberg adding almost 45,000 shares to his holding for the net amount of $379,151. During the last 6 months, institutional investors have also been showing a lot of interest in Accelerate. They have added almost 2.9 million shares to their portfolios, increasing institutional holdings by 34%.

Although there are no obvious catalysts which are driving up the share price of Accelerate, the confidence of insiders and institutions is a strong buy signal. In the last few months, shares have already rallied 90% and the heavy insider buying suggests it can go even higher.

Must Buy

LifeVantage (NASDAQ: LFVN) is a biotech involved in the discovery, development, and commercialization of nutraceutica dietary supplements. In the last 6 months, the shares have appreciated 14% due to significant improvement in sales. This improvement is due to better marketing and sales effort behind the company’s primary product Protandim. The product is a daily dietary supplement that combats oxidate stress through Nrf2 activation. The United States anti-aging market is huge with only anti-aging skincare  contributing $2.3 billion to sales.

The stock is currently trading at a forward P/E of 14x which is way below the industry average P/E. The sell side is expecting LifeVantage to double its EPS within the next two years; from $0.09 (current year) to $0.18 (2014). Insiders and institutional investors also share this positive sentiment. During the last six months, Insiders have purchased approximately 43000 shares and institutional investors have added 1.4 million shares to their portfolio. The net addition of 1.4 million shares has increased institutional share holdings by mammoth 22%.

The street is expecting LifeVantage to increase its EPS by 100% within the next couple of years. The market has still not realized the immense opportunity the company presents, and that is why the stock has moved up only 14%. Using a P/E of 24x and 2014 estimates of $0.18, we can set a $4.30 target on LifeVantage.

Bottom-line

The three companies above have seen heavy insider trading during the last six months. The revenues of Vertex are on a massive decline, and while the market is pumping it on pipeline strength, insiders don’t agree. This lack of insider confidence on the pipeline makes Vertex a terrific short target. Accelerate Diagnostics and LifeVantage have both shown solid fundamental improvements. Insiders and institutions are also increasing their holdings, which is a bullish signal for investors.

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Mohsin Saeed has no position in any stocks mentioned. The Motley Fool recommends Vertex Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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