The pharma/biotech sector has picked up pace this year after being battered by the drug pricing controversy in 2016. The first half has been pretty strong for companies in the space.

The sector does have its share of challenges in the form of rising competition, high profile pipeline setbacks, slowdown in growth of mature products and loss of exclusivity for certain key drugs. Though the drug pricing issue still prevails, investors, lately, are hoping that steep pricing will not be as damaging as feared previously.

Nonetheless, strong performance of newer drugs, evolving pipelines, impressive clinical trial results, new drug approvals, continued strong performance of legacy products and rising demand are some of the factors that promise a sustained recovery in the sector.

Meanwhile, though M&A activities and collaborations/deals have slowed down this year, chances are that they will pick up in the second half.

Q2 Performance so Far

The second-quarter reporting cycle is almost over. The earnings season has turned out to be very good, witnessing an abundance of positive earnings surprises and broad-based growth. As of Aug 4, 2017, 420 S&P 500 members, accounting for 86.7% of the index’s total market capitalization, reported results, according to Earnings Preview.

Total earnings for these 420 index members increased 11.6% from the year-ago quarter on a 5.6% improvement in revenues. The beat ratio was 74.3% for earnings and 68.3% for revenues.

In the Medical sector, while 87% of the company beat earnings expectations, 69.6% beat revenues estimates, indicating that the season has been quite strong for the pharma/biotech and the medical device companies.

Johnson & Johnson (JNJ) began the earnings season for the pharma sector with mixed second-quarter results. While it beat estimates for earnings, it missed the same for sales. Novartis AG (NVS), Eli Lilly & Company (LLY), Merck & Co., Inc. (MRK), Amgen, Inc. (AMGN), Celgene Corporation (CELG), AbbVie Inc. (ABBV)  and Biogen Inc. (BIIB) beat estimates for both earnings and revenues. Lilly and Biogen also raised their earnings and revenue estimates for 2017. However, the generic drugmakers had a dismal quarter. Teva Pharmaceutical Industries Limited’s (TEVA) Q2 earnings and sales missed expectations. It also slashed its 2017 earnings and sales outlook and cut its dividend by 75%.

How to Make the Right Pick

Given the enormity of the healthcare space, selecting stocks that have the potential to beat estimates could appear to a daunting task. But our proprietary methodology makes it fairly simple. One way to narrow down the list of choices this earnings season is by looking at stocks that have the combination of a favorable Zacks Rank – Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) – and a positive Earnings ESP.  More often than not, a positive earnings surprise delivered by a company leads to stock price appreciation.

Earnings ESP is our proprietary methodology for identifying stocks that have high chances of surprising with their upcoming earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.  You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Here are three small drug/biotech stocks that yet to report and are poised to beat estimates in the second quarter according to our methodology.

Our first pick is Puma Biotechnology, Inc. (PBYI). This small biotech has an Earnings ESP of +3.33% and a Zacks Rank #3. You can see the complete list of today’s Zacks #1 Rank  stocks here.

The Zacks Consensus Estimate for the second quarter is a loss of $2.10 per share. The company’s earnings surprise track record has been mixed, as it missed estimates in two of the trailing four quarters and met expectations in the other two. The company delivered an average positive surprise of 2.53% in the last four quarters.

This Los Angeles, CA-based company is likely to report results this month.

Our next choice is Alnylam Pharmaceuticals, Inc. (ALNY). Carrying a Zacks Rank #3, the stock has an Earnings ESP of +5.93%. The Zacks Consensus Estimate for the second quarter is pegged at a loss of $1.18 per share. This Cambridge, MA-based company has a mixed earnings surprise track record as it beat estimates in two of the past four quarters and missed in the other two. The average earnings surprise over the four trailing quarters is 3.69%.

Alnylam is scheduled to announce results on Aug 9 after market hours.

Impax Laboratories, Inc. (IPXL) also looks poised to beat expectations in the second quarter. This Hayward, CA-based company carries a Zacks Rank #3 and has an Earnings ESP of +7.14%. The Zacks Consensus Estimate is pegged at 14 cents per share.

Impax is scheduled to report results on Aug 9, before market open.

Bottom Line  

Challenges in the form of competitive and pricing pressure will remain in the healthcare sector. However, a number of companies in the space have fared well. Picking some outperformers from the space, backed by a solid Zacks Rank and a positive Earnings ESP, could lead investors to gain this earnings season.

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