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Stock Strategist

A Biotech Stock with 20%-Plus Expected Returns

Plus, other new 5-star names.

Mentioned: , ,

Following is a sampling of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.

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Moat: Wide | Risk: Avg | Price/Fair Value Ratio*: 0.75 | Three-Year Expected Annual Return*: 20.7%

What It Does:  Genentech (DNA) develops and produces biologics. Products include treatments in oncology, immunology, ophthalmology, and respiratory conditions. The firm also manufactures growth hormones for children and adults and a de-clotting enzyme (Activase) used to treat strokes. Genentech primarily sells its products in the United States with partner  Roche (RHHBY) selling the products internationally.

What Gives It an Edge: Morningstar analyst Damien Conover assigns Genentech a wide moat. According to Conover, a portfolio of best-in-class drugs affords Genentech strong competitive advantage. The firm's drugs hold strong patents that should keep competition at bay for many years. The company's next generation drugs combined with new indications for existing drugs should drive strong long-term growth.

What the Risks Are: Genentech faces regulatory risks in developing new treatments and possible generic threats with the likely introduction of generic biologic legislation. Also, the company's high-priced products can easily become a target for both cost control groups and governmental reforms.

What the Market Is Missing: Genentech's shares have declined recently due to a negative Food and Drug Administration panel vote regarding Avastin use in breast cancer. Conover believes that while the market has largely written off this drug's use in breast cancer, Avastin should receive an approval for this indication by 2010. Conover's conviction rests on the strong activity Avastin has shown in clinical trials combined with the lack of effective treatments. As such, he believes the recent price decline represents a good entry point to a high-quality biotechnology company.

Other New 5-Star Stocks
 IHOP Corporation (IHP)
 ev3 (EVVV)

* Price/fair value ratios and expected returns calculated using fair value estimates, closing prices, and cost of equity estimates as of Friday, Dec. 7, 2007.

Alex Morozov does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.