Investment: Biotech investors place bets on tomorrow's drug winners

Battered, high-risk sector still has the most expensive shares

WHAT ARE the most expensive companies on the stock market? Ask that question to a handful of US investors and they will undoubtedly refer you to the Internet companies, whose shares have been soaring again in recent days. There are few real Internet companies in the UK, but British investors would probably plump for the telecoms and computer stocks, which have been hitting new highs in recent months.

Take a look at the statistics, however, and a different picture emerges. We asked Hemmington Scott, the financial information group, to list the 20 companies in the FTSE All-Share index with the highest ratio of stock market value to revenues. (To avoid anomalies, we left out investment trusts and companies with a market capitalisation of less than pounds 10m.)

To say the least, the results were surprising. The six most highly rated shares, and 12 of the top 20, were companies in the supposedly depressed biotechnology sector. Phytopharm, which specialises in developing medicines derived from plants, topped the list, even though its share price is below the level reached almost two years ago. Based on sales of just pounds 50,000 for the year to August 1997, the ratio of market value to revenues is a staggering 1,249.

Core Group, developing new methods of delivering drugs, comes second although its share price has slumped from over 200p to 40p in less than a year. And scandal-racked British Biotech takes third place with a market value to revenues ratio of 410.

Only one telecoms stock, Colt Telecom, made it into the list, although with a market value of more than pounds 6bn the local network operator is by far the largest company in the table. London Bridge Software, which supplies software to financial groups, made the list, as did Cambridge-based ARM, which designs specialised microprocessor chips for use in mobile phones and hand-held computers.

Valuations for biotechnology shares make the highly rated Internet stocks in the US - often presented as the height of investor folly - look positively cheap. America Online, the largest Internet group in the world, had revenues of $2.6bn last year and is valued at $69bn - a ratio of 26. Amazon.com, the Internet bookseller that has taken the world by storm, is valued at 148 times its 1997 revenues.

And here is the catch. Earlier this week, Amazon said revenues for the final quarter of last year were $250m - more than it made in the whole of 1997. The figure shows the danger in taking a current market value - which discounts future prospects - and comparing it with past financial performance. For companies where sales are poised to explode, as in the case of biotech or Internet companies, conventional valuations soon become meaningless.

As a result, simple multiples of earnings and sales have been all but discarded by investors. They tend to prefer discounted cash-flow models, which carefully forecast a company's likely future performance and then express the value of future cash flows in today's money.

So Phytopharm is highly rated because investors think its drugs have a good prospect of making it to market and cleaning up. The process may take a few years, but the rewards will be worth waiting for.

"It's like panning for gold," says Andy Allars, an investment manager with Prelude. "If you have a hit you make a fortune, but you could also lose your shirt." He adds that where biotechnology companies are concerned the potential benefits are much higher because the company will have a monopoly on any drug that successfully makes it to market.

Nevertheless, the table shows that when it comes to taking a lot on trust, biotechnology investors still take the biscuit.