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Five Reasons to Look at Pharmaceutical
Stocks
Pharmaceutical companies offer unique opportunities for investors. As
the Baby Boomers age, more people must regularly buy high-margin prescription
drugs. New biotechnologies move more and better drug treatments through a
faster FDA approval process. And, managed care relies on medicines to save
money on health care costs. This industry demands an investor's attention.
By Jeff
Fischer (TMF Jeff)
The pharmaceutical business is so attractive that it's a wonder we
don't hear its praises sung more often. Airplanes should circle the planet
dropping leaflets: "Forget about investing in Coca-Cola (NYSE:
KO). Invest in leading pharmaceutical companies." The reasons for
ebullience are many.
Coca-Cola is often heralded as a repeat-purchase business. True, it is, but
only as long as people want to keep drinking Coke. Pharmaceuticals are better
than that. The chronic nature of many diseases means that a majority of
medications are anything but a one-time sale. When a patient is
placed on medication, it's often a prescription taken for several years, even
lifelong. Remember "take your medicine"? Repeat business leads to
reliable earnings at pharmaceutical companies, because each new patient
represents an annuity revenue stream.
This has always been true. Combine this fact with current demographics and
industry trends, and there is strong reason to believe that pharmaceuticals
are entering their strongest period ever -- and will only shine brighter in
the near, intermediate, and distant future. There are primarily five factors
that make leaders in this industry among the best long-term investments of
any sector.
1) A "must-repeat"
purchase, high-margin business.
Pharmaceutical companies sell products necessary for health -- not for some
discretionary need. These products usually represent a must-repeat purchase,
no matter the economic situation.
Alongside this are the high margins at which companies are able to sell
drugs. Once established, leading pharmaceutical companies often achieve
operating margins above 30%, which is twice that of the average S&P 500
company. This is possible despite high research and development expenditures.
Plus, patent protection usually guarantees high margins on new drugs for at
least a decade. (Note: Yes, patents granted today provide a 20-year monopoly
to the drug maker, but the patent usually relates back to its application
date, earlier in the drug development process, before the drug hits the
market.)
2) Favorable world demographics.
People 65 years and older use three to four times the prescription drugs used
by people in their 30s, and the world population is aging. In the United
States, the group of people 65 or older will expand 17% by 2010, increasing
the U.S. market for pharmaceuticals well beyond the current $105 billion
level. Outside the U.S., most of the industrialized world is also moving
toward the later years of life, meaning the $188 billion worldwide
pharmaceutical market will grow even more quickly than usual. U.S. firms
currently hold 30% of the world's market share for pharmaceuticals, and that
market share is rising. Plus, not only is the world's population aging, it's
also growing.
3) Improved science brings more
cures.
This positive factor represents a one-two punch for pharmaceutical companies.
Concurrent with the aging population and its logical increase in health
ailments, the pool of medications available for sale is ever-expanding.
Science has advanced as much in the past 15 years as it did in the previous
40, with biotechnology and combinatorial chemistry (the science of finding
the right compounds to work on targets -- getting the right drug to make the
required effect on the virus, or bacterium, etc.).
In short order, combined medications for AIDS that greatly prolong life have
been developed, along with blockbuster drugs like Prozac, Zoloft, and
Pfizer's Viagra, to name three.
Science continues to advance. Past success (and even failure!) almost always
extrapolates into more knowledge and more progress toward new medicines.
Perhaps more than any other industry, pharmaceutical companies are able to
grow their businesses in more directions without fear of diluting their
mission, moving beyond their core competency, or confusing customers.
Addressing health concerns is what these companies do. They can't possibly
oversupply the market with too many new products -- there are always more
ailments that need curing or treatment, and better ways to cure or treat
ailments are always welcome, as well.
In fact, ironically, as healthcare improves and the average human lifespan
increases, people need more and more drugs. For example, people are living
longer due to blood pressure medication. These elderly people need other
medications, perhaps for arthritis, Parkinson's disease, Alzheimer's, and so
forth.
4) A More Efficient FDA
Congress and the Food and Drug Administration (FDA) have agreed that
terminally ill patients have a right to use experimental drugs in the hope
that their lives can be saved or extended. These experiments allow for better
research and a faster "time to market" for new medicines. Just as
importantly, in the past two years the FDA has greatly reduced the time it
takes for a new drug to receive approval.
After years of testing and refinement, the drug manufacturer submits its
request for approval to the FDA. Between 1987 and 1993, a typical new drug
application required 26 to 32 months, on average, for FDA approval. In 1998,
it required an average of only 11.7 months. Though it inched back up to 12.6
in 1999, the process is still much faster than before.
Plus, drugs that are vitally important can be granted fast-track status and
be approved in as little as six to nine months. The more efficient approval
process brings drugs to the market quicker and allows for earlier and larger
profits. It allows for rejection sooner, too -- and that isn't a bad thing.
The earlier a company knows the FDA has rejected its drug, the quicker it can
develop a solution.
Not only this, but a quicker approval process effectively means longer patent
protection. When a pharmaceutical company receives a patent for a drug, the
legal right to exclude others from making the drug lasts for 20 years
(formerly 17 years) after the patent application was submitted. The effective
patent protection period for a successful drug is usually only about 10
years, after factoring in the time required to develop, test, and finally
bring the drug to market. The streamlined FDA approval process has chopped
two whole years from a drug's conception-to-market regimen, lengthening the
effective patent life by the same amount.
5) Managed Care Providers Rely on
Pharmaceuticals for Cost Savings.
An investor frequently hears that managed care providers are becoming
increasingly stringent regarding costs, and leading pharmaceutical companies
might suffer. In fact, an opposite argument can be made in favor of
pharmaceutical companies. The right pharmaceuticals and even a combination of
expensive drugs, if effective, can save organizations money if they keep a
patient out of the hospital.
While drugs can be expensive, they still compare favorably to the cost of
hospital stays. As patent protection effectively lengthens for new drugs,
even managed care providers are forced to provide the best -- and most
expensive -- drugs to patients. This, in turn, supports leading
pharmaceutical companies. This won't likely change as long as drugs continue
to save money, in the end, by keeping people healthier and out of hospitals.
There you have five good reasons to add pharmaceutical stocks to your
portfolio. You can use Foolish resources on the Pharmaceuticals sector
page to help you learn more and make your selections.
Feedback
about News & Commentary? Please send mail to news@fool.com.
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