Investors have been laser-focused on profit-producing companies, which has left companies in their pre-revenue stage on the sidelines. As a result, a growing number of biotech stocks are now trading below the value of the cash on their balance sheets. Over the past year, the SPDR S & P Biotech ETF is down nearly 44%, while the iShares Biotech ETF has lost nearly 23% over the same period. The steep discounts, plus a potential pick up in M & A, could spark renewed interest in the sector, but analysts say it may be wise to remain defensive in the sector. Although some of the research biotech companies are doing will inevitably yield valuable results, sorting the winners from the losers takes care. Jared Holz, a healthcare equity strategist at Oppenheimer told CNBC’s “Fast Money” earlier this week that the biotech sector needs to go through a “self-cleansing process” to redefine itself because there are too many companies that are either “non-investible or non-viable.” This would include companies that have had to halt trials or presented data that hasn’t been viewed favorably. “I think we’re at the point where some of the companies have to sort of face the facts and they have to move on from the either the program that they were starting with or … from being a company at all,” Holz said. Piper Sandler analyst Christopher Raymond expects that the true bottom for the sector hasn’t yet been reached. As in other cycles, capitulation in the group would be marked by distress signals such as fund closures and outflows from the group, which hasn’t been seen yet, he said. Instead, there has been a flight to quality that has boosted the valuations of large-cap biotech and pharma stocks, he said. Even with that, Raymond sees some reasonable entry points for stocks, including large-cap Abbvie and mid-caps Argenx and Ultragenyx Pharmaceutical , while Cogent Biosciences is his favorite “under-the-radar” small cap pick. He has overweight ratings on all four stocks. “I’ve marveled at the fact that a lot of really, really high quality stocks, when you look at their stock chart, it looks like there was a failure or some catastrophic event,” Raymond said. That may be the case for Ultragenyx. Its shares are down about 40% year to date, but there hasn’t been any material changes at the company, which focuses on finding treatments for rare genetic diseases. The company may have an update on an early-stage trial for GTX-102 for the treatment of Angelman Syndrome, a genetic disorder that causes developmental delays and difficulty with speech and balance. Raymond has a $135 price target for the stock, which is far above its current value of about $51. “If successful, [GTX-102] would totally remake this company,” he said. Abbvie’s stock chart bucks the trend in the sector. The stock has been outperforming, with its shares up nearly 9% year to date. Piper Sandler sees upside of more than 8%, with a price target at $160. Raymond’s optimism comes from his expectations for Rinvoq, a treatment for rheumatoid arthritis. His projections for the drug’s sales are above Wall Street’s consensus view for both the long and short term. Catching the early growth cycle In this environment, Morgan Stanley analyst Matthew Harrison said his focus has been on mid-cap growth names that already have one or two products approved or are in a product launch phase. This means the companies are somewhat defensive because there is revenue coming in, but they are at the very beginning of their growth cycle. BioMarin Pharmaceuticals , Argenx and Seagen are three examples Harrison cited. “These growth names are the place to be positioned because they provide the downside support, plus the upside when the market turns,” Harrison said. BioMarin shares are down about 12% since the start of the year, and the stock is currently trading at the lower end of its 52-week range. The company is starting to see the benefits of its launch of Voxzogo, the only approved therapy for children with achondroplasia, the most common form of short-limbed dwarfism. In April, BioMarin raised its sales forecast for the drug. Its other key product, Roctavian, is a gene therapy for hemophilia patients. The product has had some setbacks, with the Food and Drug Administration requesting more information from the company. A resubmitted application is expected to be filed by September. In Europe, an approval of the therapy is expected this summer. Key for investors: BioMarin is expecting to report a profitable 2022, and should bring in more than $2 billion in revenue this year. Morgan Stanley has a price target of $113 on the stock, which implies upside of more than 46% for investors. Shares of Argenx, which focuses on autoimmune disease treatments, have been recouping losses. It is currently down less than 10% year to date. The company is in the midst of launching Vyvgart for the treatment of generalized myasthenia gravis, a rare neuromuscular disorder. In addition, the company is hoping to gain approval to use the drug for as many as 10 other indications. Some of those trials are already in progress, with topline data from five trials expected by the end of the first quarter of 2023, Argenx said in its latest quarterly report. “You’ve got all of these lines of catalysts to expand the potential market size of this drug, but the lead indication is a billion-dollar plus indication and they’re off to a very strong start,” Harrison said. He has a price target of $375 for Argenx, which is about 18% above where the stock is currently trading. Piper’s Raymond has set his price target even higher, at $415, with the expectation that Argenx will continue to top estimates. Seagen’s stock is also down less than 10% year to date. The company has recently been in the news due to the departure of its co-founder and CEO Clay Siegall, who resigned in mid-May after allegations of domestic violence surfaced against him. On a interim basis, Siegall has been replaced by the company’s chief medical officer, Roger Dansey. Seagen has four approved products in its portfolio, including Tukysa, a breast cancer treatment that is also being considered for other types of cancer, including colorectal. Harrison expects the release of results from Seagen’s Cohort K study to be a potential catalyst for the stock. The study hopes to expand the use of another compound, Padcev, to treat bladder cancer. If successful, the drug to could be used on newly diagnosed patients. Right now, the drug is being used on patients with metastatic urothelial cancer, who haven’t had success with earlier treatments. “That newly diagnosed market is obviously so much bigger,” Harrison said. “And so if that data is successful, sometime in the second half of the year, it opens them up to … a new multibillion dollar sales potential.” Morgan Stanley has a $173 price target on Seagen, which is more than 23% higher than where it currently trades. The outlook for M & A Seagen also is a name that comes up when the discussion turns to M & A in the biotech sector. But so far this year there has been a dearth of deals. One factor hanging over the industry has been the regulatory environment. The Federal Trade Commission and the Department of Justice are holding a two-day workshop in mid-June to discuss the impact M & A has on competition and innovation in the pharmaceutical industry. Analysts hope the meeting will shed more light on how regulators will view consolidation in the space. Raymond said he will be monitoring the workshop. “There’s an oversupply of companies and so M & A, you know, is part of any industry’s maturation processes,” he said, adding that it’s “market distorting” to impede consolidation. Deals have started to pick up recently with Pfizer striking a deal in May to buy migraine drug developer Biohaven Pharmaceutical for $11.6 billion. On Friday, Bristol-Myers Squibb announced plans to acquire Turning Point Therapeutics for $4.1 billion, in an attempt to boost its portfolio of cancer treatments. Bristol said it expects Turning Point’s lead drug, repotrectinib, to become standard care for patients being treated for non-small cell lung cancer when it is approved, which could happen by the second half of next year. The possibility of M & A is one of the reasons investors often like the biotech sector, so it is encouraging to see some action on that front. Oppenheimer’s Holz said larger pharmaceutical companies are looking to buy biotech companies that have shown consistent revenue growth over a five- to 10-year period. With that in mind, he expects there are 15 to 30 companies with the biotech universe that could be targets. Holz said the list would include companies such as Vertex Pharmaceuticals , Seagen, Horizon Therapeutics , Incyte and Neurocrine Biosciences . The tricky part is that the valuations of some of these larger biotech companies remain pretty high relative to the rest of the group. Vertex, for example has seen its stock rise 23% year to date, while Neurocrine shares have gained about 12% since January. Funding squeeze Without deal activity, investors will likely be more concerned about funding needs. At the moment there has been a very big drop off in the pace of secondary offerings. In March, Morgan Stanley analyzed 380 biotech companies to access their cash needs. In the report, Harrison said he expected 30% of the group will have one year or less of cash on hand by the end of 2022. Since most investors prefer companies to have two years of cash on the balance sheet, hitting this benchmark typically triggers a need to raise funds. Harrison estimated that collectively the companies will need about $36 billion. The 2018-2021 time period was a peak period of investment in the biotech sector, and that pace won’t likely be repeated in the near term. Harrison said the number of companies needing to raise funds was similar to the period prior to 2018, but the amount of money needed is higher. Another overhang on the group has been the reoccurring discussion over potential policy changes that could impact drug pricing. In a research note Thursday, RBC Capital analysts warned that there is the potential for drug pricing controls to be discussed as the Senate considers a reconciliation package over the next two to four weeks. This debate could weigh on the sector as stocks try to rebound. RBC’s expert said there is a “better than 50-50 chance” that a drug pricing bill passes by the Sept. 30 deadline. “Overall, we believe the risks of drug pricing legislation making a comeback is highly underappreciated on the Street, and could have impact to biotech broadly (and perhaps even more so pharma),” the analysts wrote.