Why does the biotechnology industry have such a high PE ratio?
"If you look at the biotech breakdown, you'll find a lot of NAs when it comes to P/E since there are many young biotech companies that have yet to make a profit.  Thus, there may be something to be said for how is the entire industry stat computed. Biotechnology can include pharmaceutical companies that can have big profits due to patents on drugs. As an example, look at Shire PLC which has a P/E of 1243 which is pretty high with a Market Capitalization of over a billion dollars, so this isn't a small company.  I wonder what dot-com companies would have looked like in 1998/1999 that could well be similar as some industries will have bubbles you do realize, right? The reason for pointing out the Market Capitalization is that this a way to measure the size of a company, as this is merely the sum of all the stock of the company.  There could be small companies that have low market capitalizations that could have high P/Es as they are relatively young and could be believed to have enough hype that there is a great deal of confidence in the stock.  For example, Amazon.com was public for years before turning a profit.  In being without profits, there is no P/E and thus it is worth understanding the limitations of a P/E as the computation just takes the previous year's earnings for a company divided by the current stock price.  If the expected growth rate is high enough this can be a way to justify a high P/E for a stock.  The question you asked about an industry having this is the derivation from a set of stocks.  If most of the stocks are high enough, then whatever mean or median one wants to use as the ""industry average"" will come from that." "I want to elaborate on some of the general points made in the other answers, since there is a lot that is special or unique to the biotech industry. By definition, a high P/E ratio for an industry can stem from 1) high prices/demand for companies in the industry, and/or 2) low earnings in the industry. On average, the biotech industry exhibits both high demand (and therefore high prices) and low earnings, hence its average P/E ratio. My answer is somewhat US-specific (mainly the parts about the FDA) but the rest of the information is relevant elsewhere. The biotech industry is a high-priced industry because for several reasons, some investors consider it an industry with significant growth potential. Also, bringing a drug to market requires a great deal of investment over several years, at minimum. A new drug may turn out to be highly profitable in the future, but the earliest the company could begin earning this profit is after the drug nears completion of Phase III clinical trials and passes the FDA approval process.  Young, small-cap biotech companies may therefore have low or negative earnings for extended periods because they face high R&D costs throughout the lengthy process of bringing their first drug (or later drugs) to market. This process can be on the order of decades. These depressed earnings, along with high demand for the companies, either through early investors, mergers and acquisitions, etc. can lead to high P/E ratios.  I addressed in detail several of the reasons why biotech companies are in demand now in another answer, but I want to add some information about the role of venture capital in the biotech industry that doesn't necessarily fit into the other answer. Venture capital is most prevalent in tech industries because of their high upfront capital requirements, and it's even more important for young biotech companies because they require sophisticated computing and laboratory equipment and highly-trained staff before they can even begin their research. These capital requirement are only expected to rise as subfields like genetic engineering become more widespread in the industry; when half the staff of a young company have PhD's in bioinformatics and they need high-end computing power to evaluate their models, you can see why the initial costs can be quite high. To put this in perspective, in 2010, ""venture capitalists invested approximately $22 billion into nearly 2,749 companies."" That comes out to roughly $7.8M per company. The same year (I've lost the article that mentioned this, unfortunately), the average venture capital investment in the biotech industry was almost double that, at $15M. Since many years can elapse between initial investment in a biotech company and the earliest potential for earnings, these companies may require large amounts of early investment to get them through this period. It's also important to understand why the biotech industry, as a whole, may exhibit low earnings for a long period after the initial investment. Much of this has to do with the drug development process and the phases of clinical trials. The biotech industry isn't 100% dedicated to pharmaceutical development, but the overlap is so significant that the following information is more than applicable. Drug development usually goes through three phases: Drug discovery - This is the first research stage, where companies look for new chemical compounds that might have pharmaceutical applications. Compounds that pass this stage are those that are found to be effective against some biological target, although their effects on humans may not be known. Pre-clinical testing - In this stage, the company tests the drug for toxicity to major organs and potential side effects on other parts of the body. Through laboratory and animal testing, the company determines that the drug, in certain doses, is likely safe for use in humans. Once a drug passes the tests in this stage, the company submits an Investigational New Drug (IND) application to the FDA. This application contains results from the animal/laboratory tests, details of the manufacturing process, and detailed proposals for human clinical trials should the FDA approve the company's IND application.  Clinical trials - If the FDA approves the IND application, the company moves forward with clinical trials in human, which are themselves divided into several stages. ""Post-clinical phase"" / ongoing trials - This stage is sometimes considered Phase IV of the clinical trials stage. Once the drug has been approved by the FDA or other regulatory agency, the company can ramp up its marketing efforts to physicians and consumers. The company will likely continue conducting clinical trials, as well as monitoring data on the widespread use of the drug, to both watch for unforeseen side effects or opportunities for off-label use. I included such detailed information on the drug development process because it's vitally important to realize that each and every step in this process has a cost, both in time and money. Most biopharm companies won't begin to realize profits from a successful drug until near the end of Phase III clinical trials. The vast R&D costs, in both time and money, required to bring an effective drug through all of these steps and into the marketplace can easily depress earnings for many years.  Also, keep in mind that most of the compounds identified in the drug discovery stage won't become profitable pharmaceutical products. A company may identify 5,000 compounds that show promise in the drug discovery stage. On average, less than ten of these compounds will qualify for human tests. These ten drugs may start human trials, but only around 20% of them will actually pass Phase III clinical trials and be submitted for FDA approval. The pre-clinical testing stage alone takes an average of 10 years to complete for a single drug. All this time, the company isn't earning profit on that drug. The linked article also goes into detail about recruitment delays in human trials, scheduling problems, and attrition rates for each phase of the drug development process. All of these items add both temporal and financial costs to the process and have the potential to further depress earnings. And finally, a drug could be withdrawn from the market even after it passes the drug development process. When this occurs, however, it's usually the fault of the company for poor trial design or suppression of data (as in the case of Vioxx). I want to make one final point to keep in mind when looking at financial statistics like the P/E ratio, as well as performance and risk metrics. Different biotech funds don't necessarily represent the industry in the same way, since not all of these funds invest in the same firms. For example, the manager of Fidelity's Select Biotechnology Portfolio (FBIOX) has stated that he prefers to weight his fund towards medium to large cap companies that already have established cash flows. Like all biopharm companies, these firms face the R&D costs associated with the drug development process, but the cost to their bottom line isn't as steep because they already have existing cash flows to sustain their business and accumulated human capital that should (ideally) make the development process more efficient for newer drugs.  You can also see differences in composition between funds with similar strategies. The ishares Nasdaq Biotech Index Fund (IBB) also contains medium to large cap companies, but the composition of its top 10 holdings is slightly different from that of FBIOX. These differences can affect any metric (although some might not be present for FBIOX, since it's a mutual fund) as well as performance. For example, FBIOX includes Ironwood Pharmaceuticals (IRWD) in its top 10 holdings, while IBB doesn't. Although IBB does include IRWD because it's a major NASDAQ biotech stock, the difference in holdings is important for an industry where investors' perception of a stock can hinge on a single drug approval. This is a factor even for established companies. In general, I want to emphasize that a) funds that invest more heavily in small-cap biotech stocks may exhibit higher P/E ratios for the reasons stated above, and b) even funds with similar mixes of stocks may have somewhat different performance because of the nature of risk in the biotech industry. There are also funds like Vanguard's Healthcare ETF (VHT) that have significant exposure to the biotech industry, including small-cap firms, but also to major players in the pharmaceutical market like Pfizer, Johnson and Johnson, etc. Since buyouts of small-cap companies by large players are a major factor in the biotech industry, these funds may exhibit different financial statistics because they reflect both the high prices/low earnings of young companies and the more standard prices/established earnings of larger companies.  Don't interpret anything I stated above as investment advice; I don't want anything I say to be construed as any form of investment recommendation, since I'm not making one." Residential Construction at 362x, by the way. I'm going to hazard a guess here - Say XYZ corp trades at $100, and it's showing a normal earnings of $10 the last few years. Its industry falls on hard times, and while it makes enough to keep its doors open, profits fall to $1. The company itself is still sound, but the small earnings result in a high P/E. By the way, its book value is $110, and they have huge cash on the books along with real estate.  I offer these details to show why the price doesn't drop like a rock.  Now, biotech may be in a period of low reported earnings but with future results expected to justify the price. On one hand it may be an anomaly, with earnings due to rise, or it may be a bit of a bubble. An analyst for this sector should be able to comment if I'm on the right track. Most biotech companies do not have a product they are selling.   They have a set of possible drugs that they are developing.     If any of these drugs get proven to be better than the current drugs they can be sold at a great profit. Therefore as soon as a biotech company proves a drug candidate is likely to pass large scale trials the company is often taken over by a large pharmaceutical company and is therefore no longer listed on the stock market. So mostly profit comes after the company stops being listed, therefore the profit will be negative for most biotech companies that are publicly traded.
"What folks here don't get is it's generally in the industries interest to not mislead. As you may have noticed, folks don't like being mislead. Yes, it happens, but the large majority of companies consider it in their interests to label clearly.  Are you aware that General Foods is strongly lobbying to mandate GMO labeling? Or that the pork industry is making a strong (hopefully successful) effort to change the rules about ""natural"" nitrites so that they're labeled like any other nitrite? I'm guessing you're not, and instead are just making unfounded assumptions." complete fucking bullshit line of thinking.  There are far more expensive industrial development (silicon fabrication, each fab cost $3-15Billion). You don't see Samsung running around begging for patent extension do you?  The pharma industry is bunch of con artist and scum. It has always been like that. (You do know Merck originally sold opium right?) High ROI and high barriers to entry are rare to find existing together at the same time in the same market. More commonly, you have high margins/ROI in early markets, but high barriers to entry are more common in mature markets. The most common places to find high ROI and barriers to entry is when there is something *proprietary* involved. This is why the STEM (science, technology, engineering, and math) fields are so valuable. Industries related to these fields have an edge because they are the most likely fields to create something proprietary. When something proprietary is also in high demand, you have a barrier to entry and also a potential to create high margins (which in turn will be high ROI). Some people have mentioned medical devices, which are an excellent example. There are only a handful of companies that have went to the lengths of development to create the Swan Ganz catheter, for example (an essential tool used in cardiac surgeries). With little competition and high demand, companies that manufacture Swan Ganz catheters can put healthy margins on the product without worry.  TL;DR: The best way to find something high ROI that also has barriers to entry is to specialize towards something proprietary that cannot be imitated or replaced, but is also in high demand. Well a huge difference in drugs compared to all those other industries is health regulation. Standards for new medicines are typically extremely higher compared to other industries. For example, when proposing a new drug, only 10% of them actually make it to market. I don't understand why this article keeps speaking in absolute dollar terms. GE is a massive company, so of course all the numbers look big.  The 67% funded status is the key point. That number isn't great, but it isn't terrible. I bet most multi-industrial companies are in that ballpark. The reason is that China has identified a problem, has found a solution, and has realized the solution is worth billions in the new energy markets. It can solve a problem while becoming a leader in the largest industry in the world.  Meanwhile the US has politicized science and is debating if there is a problem at all. The article briefly mentioned Martin Shkreli and Daraprim, which is an excellent extreme example of the underlying flaws in the American medical market. Hide the true costs of various necessary medications behind multiple walls of insurance pools and government subsidy and pretty soon the sky's the limit for these companies: https://rebelnews.com/willparke/the-drama-of-daraprim-and-the-for-profit-medicine-industry/ I agree with the article, but one thing I wonder about: how much is driving suppressed because of the relative high price of gasoline and the relative lack of fuel efficiency in cars? In other words, are we going to put more cars on the road and drive on average more km per yr per if we have a sort of quantum leap in fuel efficiency? Not necessarily a bad thing, but perhaps something that makes achieving foreign oil independence a bit harder than we might think. One problem is that P/E ratio only looks at the last announced earnings. Let's take your manufacturing plant with a P/E of 12.5. Then they announce a major problem that will hurt future earnings and the price drops in half. Now the P/E is 6.25. It looks great, but since there aren't any new earnings that reflect the problem, it's very misleading. "In general, when companies are regarded as ""hot"" growth stocks, they are expected to keep up an accelerated level of growth for a good long time. That accelerated growth justifies a high PE relative to a slow-growth stock. When companies that are supposed to grow miss expectations or (worse) lose money, the markets punish the stock severely... Particularly if the company doesn't make analysts aware of problems early on. Netflix is a great example of a company bungling a few different business problems, creating a much bigger one in the process. A poorly conceived rate hike killed the reliable cash flow of the company, and that crazy Quixter thing just confused everyone. Now nobody trusts the management. BlackBerry is another example of a high performing company that just screwed up, damaging shareholders in the process. We're living in a very challenging era today, but growth stocks are always risky by nature -- growing a company rapidly is very difficult." The operating margin deals with the ability for a company to make a profit above the costs of running the company and generating sales. While ROE is how much money the company makes relative to the shareholders equity. I'd be willing to bet that if a company has a small ROE then it also has a quite large P/E (price to earnings) ratio. This would be caused by the company's stock being bid up in relation to its earnings and may not necessarily be a bad thing. People expect the high operating margin to help drive increased revenues in the future, and are willing to pay a higher price now for when that day comes. "Can you elaborate? What other countries are you talking about?   It's definitely not uncommon for publicly funded ""healthcare"" (unsure why you put this in quotations) to go to corporate revenues / profits. Canada and Switzerland are two examples off the top of my head who use similar systems. Many other countries use a private sector component.   ""The margins are huge"" largely because of government involvement. The bloated Resource-Based Relative Value Scale (RBRVS) standardized payment scheme determines payments for services based on the resource costs estimated by a committee that meets in private (the Relative Value Update Committee).   This impractical archaic value system has been adopted by 80% of private insurers, impairing their ability to drive down and offer more competitive prices." "This is just trade warfare.   China is rejecting loads based on the presence of the ""Vipterra"" corn trait which is just another BT variant from Syngenta.   China has only rejected loads from America based on the presence of Vipterra despite every single load coming from Brazil and Argentina having this trait present. Vipterra is grown a ton in South America due to the very high insect pressure." Most of the money gained through PE is done through financial engineering/deal structuring. There are funds that are operationally focused which do make changes on the portfolio company level. From what I have seen, most people who are operationally focused do not achieve that much in the way of results. Picture it as consulting, except that the results of your initiatives are actually important.    As for turn-arounds, there are funds that specialize in that. Golden Gate Capital comes to mind. These are far more exciting investments, but can be very frustrating. If you want to look at it in terms of the public markets, turnarounds in PE are essentially levered value investments. It is likely that you aren't going to change the business much, but are actually just buying an out-of-favor business and waiting on the industry to bounce back.    The argument that PE funds just gut companies and sell with the new higher operating profitability is somewhat flawed. There is really only so much cost cutting you can do, once you have fired staff or corrected a mistake you won't likely have more chances to gain from that original problem. What people should be criticizing is that funds often cut capex and reinvestment to increase results at the expense of the future profitability of the company. Is this a joke?  Equity research and investment banking jobs have historically been handed out to top Ivy grads who know nothing about finance and learn it on the job.  It's changing now because of the competiveness but that statement is just ridiculous.