The use of valuation models by European biotechnology analysts

Abstract

This paper aims at examining the practical use of valuation models by European biotechnology analysts. The study is based on a self-administered questionnaire with 39 sell-side analysts, and is complemented with semi-structured face-to-face interviews. We find that most professional analysts prefer the risk-adjusted net present value (rNPV) model. The main reasons to the popularity of the rNPV model seem to be driven by both client-driven preferences and the ability of the analyst not to be restricted in changing its forecasts. We also find evidence, using a non linear variant of the Principal Components Analysis, of four ways of valuing biotechnology firms. These variations in valuation models seems to some extent be driven by the maturity stage of the company, but also by preferences of the users (analysts). The preferences of the users become even more apparent when analysts determine critical input parameters to the valuation models. Some of these clearly deviate from what classical financial theory suggests. We conclude that the stock price determined by analysts’ valuation models is only part of the entire valuation story and subjective factors play a crucial role in the investment recommendations.