Having delivered some of the best performances in the stock market so far in 2020, biotechnology shares have encountered a brutal correction over the last few weeks.

Investors might be feeling bruised after seeing in some cases shares losing over half of their values, while on average they have dropped just over 40% in value from recent highs, as the table shows.

Part of this downdraft is probably the result of too many investors chasing share prices higher on the latest regulatory announcements, creating what is sometimes called a crowded trade. This refers to buyers becoming more aggressive, paying little attention to the price they pay, almost willing to pay any price just to get a piece of the action.

Once the surge in buying is over, the market tends to fall back until it finds a better equilibrium between buyers and sellers. This can then be exacerbated by profit taking from buyers who got in early, looking to lock in their gains, leaving the latecomers licking their wounds.

Even so, all the companies in the table have at least doubled in value over the last six months, which is remarkable in current market conditions.

There was always going to be a time when investors focused more on the economic reality rather than just the story. This may mean that shares tread water while the fundamentals catch up with the valuation.

This looks like the case for leading performer Novacyt (NCYT:AIM) which launched one of the earliest Covid-19 test kits at the end of January. In a recent update the company confirmed it had received orders worth a total value of €135m with new contracts in Zimbabwe and South America.

Even after falling by half the market capitalisation of €144m is nearly 50 times expected 2020 net profits of €3m, according to data from Refinitiv.

Another reason for caution is the ever-increasing number of competing products that have appeared over the last few months, all hungry to meet the huge demand for coronavirus testing as well as     antibody testing.

For example Omega Diagnostics (IDH:AIM) has interests in five Covid-19 testing opportunities, Genedrive (GDR:AIM) has developed a one-step, ready-to-go freeze dried test, while Avacta (AVCT:AIM) is due to launch a mass market testing strip in the summer.

In other words, the lions’ share of price gains for the sector are probably behind us and further gains will be driven by companies which can translate orders into profits.

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