SHARES

Good news ahead for this biotech stock

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This week's Hot stock is courtesy of Skaffold's Chris Batchelor.

Sirtex Medical (ASX: SRX)

Key statistics:

biotech

Closing share price 5-7-16: $26.09

52-week high: $41.33

52-week low: $25.10

Most recent dividend: 20c

Annual dividend yield: 0.76%

Franking: 100%

Sirtex Medical is a biotechnology stock that is focused on developing solutions to treat people with liver cancer. With a market capitalisation of $1.5 billion, it is considered a small-cap stock but it is by no means tiny. Unlike many biotech companies, Sirtex is already a very profitable company. In 2015 it generated a profit of $40 million, which represented growth of 70% on the previous year. The profits for 2016 will not be released until August but they are forecast to be $54 million.

The earnings trajectory for Sirtex is very strong. Earnings per share have grown at 26% over the past five years and are forecast to grow at 29% over the next three. The current forecast price-earnings ratio is 28, which is on the high side but not unreasonable for a company with such strong growth prospects.

When evaluating a business it is essential to check its cash flow. Occasionally a business will report great paper profits but the supporting cash is ethereal. Slater & Gordon (SGH) and Shine Corporate (SHJ), the plaintiff litigation firms, were good examples of that. They were booking profits based on assumptions about how many cases they would win, and those assumptions proved to be overly optimistic. Both firms were generating operating cash flow well below their reported profits and both have since had a day of reckoning with major share price falls. Sirtex, on the other hand, generates cash that is well in excess of its reported profits. This gives us a lot more confidence in the numbers.

Since Christmas Sirtex's share price has dropped from around $40 to about $26. This 35% decline was due to slightly disappointing results in its European business. The shares are now trading very close to their estimated intrinsic value with a projected increase in intrinsic value of 24% over the next year.

It is important to remember that biotechnology stocks are inherently risky. So much hinges on the outcomes of research. In March 2015 Sirtex announced the preliminary results of a trial it was conducting to see if one of its products showed a marked improvement for people in the early stages of cancer. The findings did not show a significant improvement and the market reacted harshly. The stock price plunged 55% in a single day.

Share price volatility is par for the course with biotech stocks. However, such volatility can present opportunities for those with a strong stomach and the patience to wait.

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