Biotech stocks have been on an incredible tear over the last five years, achieving something no sector has ever done before. But does this mean we’re in a biotech bubble? Credit Suisse analysts say we aren’t… yet (although value investors will take the report with a grain of salt).

Biotech sector outperforms the S&P 500

Since the beginning of 2011, analyst Ravi Mehrotra, Ph.D. and his team said biotech stocks have returned 204%, compared to the S&P 500’s 64% return. In fact, the sector is up almost 400% since the last peak, which they say was reached “during the mother of all bull markets,” the 1999 / 2000 dotcom frenzy. All charts and graphs in this article are courtesy Credit Suisse.

Biotech S&P 500

They report that the five large cap biotech stocks have a cumulative market capitalization of $513 billion, compared to $128 billion at the beginning of 2011. The biotech sector has been the best-performing sector for the last five consecutive years.

Biotech S&P 500

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And Wall Street has been happily gobbling up all the biotech it can get, as there were 82 initial public offerings in the sector last year, compared to the last peak of 67 in 2000. So far this year, there have already been 12 IPOs, and it’s now considered the norm for SMID caps to have valuations in the multi-billions of dollars.

Biotech S&P 500

Currently there are 44 public biotech companies with market caps of more than $2 billion, not counting the five large cap biotechs. Just one year ago, there were 26, and in 2011, there were only 14.

A biotech bubble? Not so much

In spite of the tremendous performance of the biotech sector, the Credit Suisse team doesn’t think we’re in a biotech bubble, although they admit that “maybe the pendulum has over-swung a little.” Instead, they say we’re “in a new era for biotech driven by fundamental changes in large and SMID cap biotech.”

They argue that large cap biotech companies have evolved into a “Biotech 2.0” business model and are leading the industry with their margins and growth rates. They also explain where they think the next step in the biotech industry must take companies:

Biotech S&P 500

However, they also point out that large cap biotech stocks trade a lower forward price to earnings multiples and have higher growth rates than the S&P 500.

Wall Street is eating up “cool science”

They believe the SMID cap business model has also changed from a “pick-and-shovel leasing for small royalties on any oil discovered” model to a “owning the (potential” oil-well.” They think the driver of this change is the “robust” financing window we’ve been in.

“‘Terminal value’ of large caps and recent M&A premiums combined with ‘all the cool science’ add to the perfect (good storm) for SMID caps,” the analysts wrote.

Among the “cool science” they list are gene therapy, RNAi, stem cells, CAR-T, and Egg precursor cells.

“These technologies are unquestionably super-scientifically interesting, but FYI none of them are new per se with the genesis of these technologies frequently going back to more than 20 years ago,” they explained.

They say it’s understandable that investors are ga-ga for biotech right now because of how much our scientific understanding of these technologies has grown in the last decade and the companies’ ability to attract financing through the equity markets.

And finally, they sum up the bull and bear theses for the biotech sector in one tidy image:

Biotech S&P 500

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