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Here's Why Genetic Testing Stocks Lost as Much as 26.1% in May

Maxx Chatsko, The Motley Fool

What happened

The genetic testing industry has been the source of epic growth in recent years, but investors were forced to wade through significant volatility last month following the release of first-quarter earnings results. Shares of Invitae (NYSE: NVTA) led the cliff-diving with a loss of 26.1% in May, followed by a 21.3% decline for Myriad Genetics (NASDAQ: MYGN) and an 18.8% tumble for Genomic Health (NASDAQ: GHDX), according to data from S&P Global Market Intelligence. Invitae is the only member of the trio that posted a positive year-to-date gain.

Wall Street clearly didn't like the business updates from around the industry. However, a closer examination suggests the pessimism is misplaced. Invitae seized an opportunity to rapidly expand revenue at the expense of short-term operating income, while Genomic Health is delivering on metrics that matter most for a well-positioned genetic testing leader. Myriad Genetics, which continues to struggle to grow newer products in an appreciable manner, may have been the only business that deserved a steep haircut.

A researcher in the lab with a disappointed look on his face.

Image source: Getty Images.

So what?

Invitae surprised Wall Street analysts by changing its near-term strategy. Instead of continuing to decrease cash burn and gradually shrink operating losses, CEO Sean George said the business will plow capital into growth opportunities to "put even more distance between Invitae" and its competitors by the end of 2020. That could cause full-year 2019 cash burn to increase 50% year-over-year, although management is confident the investments will deliver more than $220 million in revenue this year and $500 million in revenue in 2020.

That's one heck of a leap in revenue -- and it will depend heavily on the success of the upcoming commercial launch of the company's direct-to-consumer sales channel. Invitae plans to offer clinical-grade genetic tests to individuals without insurance companies or doctors acting as middlemen. Customers will have access to expert interpretation of the results from genetic counselors and a follow-up from a clinician. If the platform succeeds, then it could fundamentally change healthcare and the company's growth trajectory.

While Wall Street analysts sold the idea of wading through more red ink at Invitae, they seem to be misunderstanding the most important drivers for Genomic Health. The business grew Q1 revenue 17% year-over-year and delivered operating income of $11.5 million, almost half of last year's total. Shares fell 11% on the quarterly update.

A rainbow-colored umbrella in a sea of black umbrellas.

Image source: Getty Images.

The miscommunication appears to stem from analysts narrowing in on the average selling prices (ASPs) of genetic tests, while Genomic is focused on expanding market access for its tests. The latter is more important. For instance, selling directly to customers or expanding its presence in European markets with more regulated healthcare markets than the United States both result in lower ASPs, but the increase in testing volume is a better indicator of long-term success.

Wall Street's infatuation with ASPs is probably the result of stumbling growth at Myriad Genetics. Unlike Invitae or Genomic Health, the genetic testing pioneer has a legacy business from the old days of patented genes and low-volume sales of proprietary tests. That segment has struggled to adapt to the high-volume, low-cost reality of today's industry. Making matters worse, the pioneer's efforts to build a competitive portfolio of products using the current industry playbook hasn't enjoyed the same success of its peers.

Therefore, investors might want to tread carefully with Myriad Genetics stock, especially considering a significant chunk of its adjusted earnings growth comes from accounting, rather than improving performance.

Now what

Any industry capable of producing triple-digit revenue increases is bound to encounter turbulence here and there. That said, Wall Street may have overreacted a bit to recent updates from Invitae and Genomic Health, which appear to be on a solid long-term trajectory. Opportunistic investors with a long-term mindset might want to give them a closer look.

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Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Genomic Health. The Motley Fool has a disclosure policy.