There are some companies and indeed whole industries, where share-tipping is based purely on speculation. Biotechnology is a field where it is very difficult to predict which companies will launch a product that delivers spectacular returns and/or become takeover targets for the big players in global pharma. Relatively young companies listed on the alternative market, often burn through cash in their quest to launch ground-breaking new drugs or medical devices. Added to this, the shares can be thinly traded and the free float restricted, so any set-backs in terms of trial results, regulatory news and contracts, can see magnified falls in share prices.
The trade-off for all these risks, is that potential rewards can be huge. Take Abcam (ABC) which has grown exponentially since it first listed on Aim, thanks to massive uptake of its tools and scientific support to the global research community. The share price has risen over 40 per cent in the last twelve months alone (although there was a notable wobble in early September as annual numbers that were just ‘in line’ with management expectations concerned investors).
Our Alpha Case Study is a company that is already on a forward multiple of 32 times future earnings but that doesn’t tell the whole story. The revenues are based on secure licence deals, so it is in a strong position to meet profit expectations. The company is cash generative and highly solvent and it has a strong track record of growing its dividend. All this quality is priced in of course, and it isn’t cheap, but if we apply the valuation only to the largely known future revenues then we have a company with a future earnings yield of three per cent.
If we take this approach to valuation, then any positive surprises to the upside are effectively free into the bargain. Intriguingly, the prospects for uptake of a new heart disease test using this company’s products, could be much better than allowed for in the revenue forecasts. There are also tests under development that are not included in the valuation.
Talking of products under development and good news surprises is, of course, where we get into the realms of speculation, so we avoid even attempting to predict upside beyond the revenues forecast based on existing licence deals. This report is not a tip, it's more a case study of how to analyse the prospects for a company in an exciting space, where it is necessary to soberly assess known and unknown factors. What is clear, however, is this company has an in-built margin of safety for those who choose to pursue a Blue Sky play on its further prospects.
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