Biotech stocks are as sizzling as summer weather, especially for investors who are willing to buy into the sector at valuations not seen since the dot-com bubble.
But thanks to a lack of investment institutions following those hot stocks higher and a rising sentiment that recent results may not be indicative of near-term growth prospects, many individual investors are suffering from what I like to call the biotickr.com of biotech investing.
What's even worse is that these same individual investors would have missed out on some major moves. Just in the past two weeks, the Nasdaq Biotechnology Index has soared 18 per cent, or 5.5 per cent, to its highest level since March.
It all means that, though the tech-heavy Nasdaq index just reached an all-time high, the benchmark Canadian index is still near its most recent high. In fact, it reached its record level a year ago.
Tough times, right? Well, yes and no.
Just because the index has hit another record high does not mean that you should jump in and go gung-ho with investing in these biotechnology stocks.
Rather, before investing your money in these hot stocks, consider the impact of how much you are willing to pay, or will pay, for an investment.
I found an online calculator that can help you figure out how much of your portfolio should be devoted to a sector. It can also help you figure out the risk you'll have to endure if the sector takes a turn for the worse.
The tool, which is produced by Bespoke Investment Group, is called the "Leverage Weighted Asset Ratio."
If you're an individual investor with $200,000 to invest, for example, this tool can tell you to put 30 per cent of your portfolio into the utilities sector or 15 per cent into health care. If you want to put 25 per cent of your money into high-yield bonds and let the rest of your portfolio be in an environment-friendly gold ETF, you should be able to figure out how much you should allocate.
The tool takes into account a stock's total return (including dividends), its volatility and its overall quality. For example, if a biotech stock such as Vertex Pharmaceuticals Inc. has an annualized volatility of 22 per cent, that represents a lot of risk if the stock's upward trajectory stalls.
By taking into account your risk tolerance, your goal is to figure out the maximum amount of money that you can commit to a particular sector. This way, you can look at whether or not there are opportunities for investment at these high valuations.
The Bespoke Investment Group tool will calculate the percentage of your portfolio that should be dedicated to each of the 11 sectors in the United States, as well as sectors in Canada.
The Canadian sector provides a few additional challenges for investors. While the U.S. markets are valued at historically high levels, the Canadian markets are not on a par with their American counterparts. Canada's S&P/TSX Composite Index trades at a price-to-earnings ratio (P/E ratio) of 18.9, compared with an average P/E of 20.4 for the S&P 500 index.