Regardless of Hype, Is There Still Upside in This Stock?

In the last week alone, Pharmacyclics has been upgraded three times! These calls led to double-digit gains over the last week, and new all-time highs. While Pharmacyclics' lead product ibrutinib, which treats various forms of blood cancer, is remarkable, there comes a point where valuation must be considered, and risks acknowledged.

A fury of upgrades
Pharmacylics began the week priced at $120 (now $135) and here are the analyst upgrades that added more than $1 billion to the company's valuation.

• William Blair has a price target of $143 on Pharmacyclics, suggesting a market cap of $10.4 billion. The firm notes a great safety and efficacy profile, saying ibrutinib could become the largest product in hematology oncology history.

• JPMorgan issued its $142 price target on Thursday, but did acknowledge that the stock is not cheap. The firm called ibrutinib "de-risked," noting its safety/efficacy profile and its multiple "breakthrough therapy" designations. Earlier this year, Bloomberg reported that ibrutinib's breakthrough designations meant that an FDA approval would come two years ahead of schedule, while also removing the risk of an FDA decision. With ibrutinib expected to earn its first FDA approval within months, it appears as though Bloomberg was right.

• Deutsche Bank trumped all calls with its $170 price target, representing a market cap of $12.4 billion. Deutsche's reasons were similar to those of its peers, but Deutsche insists that the $6.4 billion consensus for peak sales is too conservative, saying it expects sales to eventually reach $9 billion.

Foolishly ignoring the risks
In five years, Pharmacyclics has rallied an incredible 6,500%. With that said, price target hikes follow a familiar pattern with analysts, which include riding the trend of a stock. Hence, if Pharmacyclics keeps ticking higher, then keep upgrading it.

The problem with Pharmacyclics is valuation, and the fact that ibrutinib is not yet FDA approved. Analysts, investors, and columnists are apparently assuming that peak sales will be met, but seem to have forgotten that only two of ibrutinib's indications have completed clinical studies, and that Pharmacyclics must still prove itself worthy in other indications.

Moreover, there is still debate as to whether ibrutinib will expand from the relapsed/refractory setting to front line and maintenance use in treating the disease. Given the lofty valuation and sales targets, investors are expecting all pieces to fall in place, but in biotechnology, this is not always the case.

Reminds me of another
In many ways, the hype and excitement surrounding ibrutinib is reminiscent of Alexion Pharmaceuticals' Soliris. This is a product that treats ultra-rare genetic and blood disorders, and with only $1.32 billion in annual sales, its stock has already risen to a market cap near $23 billion.

Analysts peg Soliris with peak revenue between $4 billion and $5 billion, which is an estimate based on all five of the drug's additional indications being approved. Currently, it is only approved to treat two diseases, but with a $23 billion market cap, success has apparently been awarded despite no clear evidence that these indications will be approved.

Moreover, when talking about peak sales and the potential of a product, investors must remember that even if ibrutinib reaches peak sales of $6.4 billion (by 2020), Pharmacyclics will only earn $3.2 billion due to a partnership with Johnson & Johnson. Therefore, if we look at valuations as they sit today, Alexion trades at 4.6 times peak sales, and Pharmacyclics is trading at 3.1 times peak sales.

A better investment
In a previous article, I provided data showing that the average drug company trades at 2.9 times sales. In theory, this ratio multiplied times peak sales would represent peak value, assuming peak sales are reached. Thus, it is clear to see that Pharmacyclics has likely priced all of its upside before earning an FDA approval.

Using this metric as a guide, and also seeking companies with a high likelihood of an FDA approval, Acadia Pharmaceuticals presents far more upside compared to Pharmacyclics. Its lead drug pimavanserin met primary and secondary endpoints in a phase 3 study that is equally impressive as ibrutinib.

Pimavanserin not only demonstrated antipsychotic efficacy in treating a disease (Parkinson's disease psychosis) that has no FDA-approved products, but did so without producing the side effects found with other antipsychotic medications.

Given these results, Acadia does not have to complete a secondary study, which is also a good indication of a future FDA approval (expected next year), and solidifies its place atop the antipsychotic market. Combined with the indications of schizophrenia and Alzheimer's disease psychosis, sales of pimavanserin could exceed $2 billion annually. Thus, Acadia is trading at just 1.2 times peak sales, and in a very large antipsychotic industry.

Final thoughts
With all things considered, there doesn't appear to be much long-term upside in shares of Pharmacyclics -- or Alexion for that matter. But there is upside in other companies such as Acadia. While it's easy to buy into the hype, retail investors must remember the risks, and understand that not all dominoes may fall in place. In the case of Pharmacyclics, this fact makes an investment very risky, as most gains have been realized.

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The article Regardless of Hype, Is There Still Upside in This Stock? originally appeared on Fool.com.

Brian Nichols owns shares of Acadia. The Motley Fool has no position in any of the stocks mentioned. 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.

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