How to invest in Pharma stocks

First of all, I want to wish each and every one of you readers a Merry Christmas. I hope you had a great long weekend. In my last article I showcased what the most prominent Pharmaceutical companies in the current market are. I also ended with a bit of a teaser, mentioning that I would explain what to look for when you want to invest in Pharma stocks, and today I’m here to deliver, so let’s get started!

“Slow and Steady” Wins the Race

We’ve all heard the story of the tortoise and the hare. How the tortoise slowly makes its way to the finish line and how it wins over the hare, who decided to take a break and ended up losing. Well, the same with Pharma stocks. Most of these stocks won’t give you the sky-high growth generated by many technology stocks.

The four companies we mentioned in the previous article [ADD LINK] have promising product lineups and a promising pipeline, and more importantly, all offer dividends which is a great way of increasing the attractiveness of a company.

Key Elements in Pharmaceutical Stocks

Now while I’ve given you some Pharma companies to look at, that doesn’t mean that you can’t look out for others on your own. However, the first thing you need to know is the difference between pharmaceutical stocks and biotech stocks. Strictly speaking, pharma companies use chemicals to develop drugs, while biotechs make drugs using living organisms like bacteria or enzymes.

The most important thing to look for in pharma stocks is their growth prospects, demonstrated by their revenue and earnings growth. Slowing growth could hint at increased competition. Find out when their drug patents expire, because losing patent exclusivity opens the door for lower-cost generics to enter the market.

Another key component to a pharmaceutical company’s growth prospects is its pipeline; all of the drug candidates currently in development. Most drug companies include in their pipelines only these drug candidates in clinical testing in humans or awaiting regulatory approval from applicable government agencies.

These candidates can be drugs that are approved for one indication (specific diseases and sometimes specific age ranges for a disease) but have not yet been approved for another indication. Gaining approvals for additional indications is a great growth opportunity for drugmakers.

Some companies also include drug candidates in the early development stages of drug discovery (where drug candidates and the diseases they could potentially target are identified) and preclinical testing (where drug candidates are tested in test tubes and/ or living animals).

The more a drug candidate is qualified and advanced, the more likely it is to contribute to a drugmaker’s growth. There are typically three phases involved in clinical testing:

Phase 1: Small studies designed to find a safe dose for the drug candidate and determine how it affects humans.
Phase 2: Studies that can include 100 or more patients and that focus on determining the safety, short-term side effects, and optimal dose of the drug.
Phase 3: Larger studies that can include hundreds or even thousands of patients and focus on how effectively an experimental drug treats a target disease plus how safe it is.

Each phase is a hurdle a drug candidate must clear to finish the race. A candidate has to successfully complete each phase to advance to the next phase. After successful completion of phase 3 testing, a pharma company files for regulatory approval. The Food and Drug Administration (FDA) evaluates all drugs in the U.S. The European Medicines Agency (EMA) has the same responsibility in the European Union.

The average cost of developing a new drug is $2.6 billion. It takes an average of 10 years to advance a drug from discovery to approval. However, the FDA can expedite the process by granting a drug breakthrough designation, orphan drug status, or priority review.

Dividends - a portion of earnings companies return to shareholders - are another important factor to consider when evaluating the stocks of big pharma companies. During the lifetime of the SPDR S&P Pharmaceuticals ETF, dividends have generated nearly one-third of the ETF’s total return.

Risks of Pharmaceutical Stocks

I would be remiss if I didn’t give you the risks involved when deciding to invest in these types of companies. There are several factors that determine how risky a certain company is in this field, however here are the most important ones.

Potential of clinical failure: Chances are especially high that early-stage candidates could fail to be effective or safe in clinical trials. Even drug candidates in phase 3 testing can flop, though.
Possibility of failing to win regulatory approval: While a drug could sail through all clinical testing phases, there’s no guarantee it will win approval from regulatory agencies.
Challenges in securing reimbursement: Pharma companies must convince payers, including government programs or health insurers, to cover their drugs. Payers can pressure pharmaceutical companies to set drug prices lower than they hope for.
Competition: The pharma company can face competition in the marketplace, especially when generic versions of a drug enter the market after the drug loses patent exclusivity.
Product liability and litigation: Drugmakers can face liability issues related to their products. Some companies have recalled drugs from the market due to safety concerns, and lawsuits are also common.