Gilead Sciences, Inc. (GILD), Celgene Corporation (CELG): Is This the Next Investing Bubble?

With the Nasdaq Biotechnology Index hitting record highs, Motley Fool health care analyst Max Macaluso and Fool contributor Brian Orelli sat down to chat about whether we’re in a biotech bubble. Their conversation follows:

Max Macaluso: So, Brian, generalist investors love looking at indexes — like the Dow Jones Industrial Average, S&P 500, or Nasdaq Composite — to feel the pulse of the broader market. It’s important to stay in tune with how the overall market is performing, but we both focus on the biotech sector. How can biotech investors get a quick snapshot of how stocks in this industry are performing?

Brian Orelli: There are a couple of biotech indexes: the AMEX Biotech index (^BTK) and the Nasdaq Biotechnology Index (^NBI). And then there are some ETFs that track those funds or another basket of companies they’ve created, the SPDR S&P Biotech (ETF) (NYSEARCA:XBI), iShares NASDAQ Biotechnology Index (ETF) (NASDAQ:IBB), and First Trust NYSE Arca Biotchnlgy Indx Fd (NYSEARCA:FBT)for example.

I think most people follow the NBI or the iShares ETF that tracks it.

Macaluso: The Dow Jones Industrial Average is hovering near an all-time high. Is the NBI also hitting record highs?

Orelli: It just hit a record high, but we have to go further back than 2007 — the last time the Dow was at an all-time high. The NBI was at this level back in 2000. Like the dot-com bubble, the biotech bubble burst, and it’s taken us this long to recover.

Macaluso: You’re drawing an eerie parallel here… do you think we’re in another biotech bubble right now?

Orelli: I don’t think we’re in a bubble. I was still in grad school during the last one, so I wasn’t covering the sector as closely as I do now, but I remember the euphoria for biotech. In contrast, I don’t think valuations are over the top today.

Keep in mind that overall value should go up over time. Companies are pumping billions of dollars into R&D. That should be creating more valuable companies. If it isn’t, we have a problem.

Macaluso: So if valuations across the industry aren’t inflated at the moment, what’s behind the biotech industry’s incredible run lately?

Orelli: The index has run up in large part because of a couple of key components that make up a large portion of the index.Regeneron Pharmaceuticals Inc (NASDAQ:REGN) for instance is over 8% of the index. Its macular degeneration drug, Eylea, has been selling better than investors — and the company for that matter — had expected. Shares are up over 50% over the last year.Gilead Sciences, Inc. (NASDAQ:GILD) has almost doubled over the last year as investors have high hopes for its hepatitis C franchise.

That’s the thing about indexes. There are 119 companies in the NBI. Euphoria for all the little guys can move the index, but so can monster moves by a few of the big companies. Those might be overvalued now — it depends on whether Regeneron can develop more drugs and, for Gilead Sciences, Inc. (NASDAQ:GILD), whether the hepatitis C market is as large as people think it is — but even if they fall a little, we won’t have a bubble burst like we did in 2000 when the index fell 70% over the course of two years.

Macaluso: Regeneron and Gilead Sciences, Inc. (NASDAQ:GILD) are two of the biggest biotech success stories from last year, but what about the losers in this industry? When a small biotech with one drug in development receives an FDA rejection, for instance, it can lose 80% or more of its value overnight. How do cases like this affect the NBI?