A healthy dose of drug stocks has turned out to be the proper investment prescription during this lingering recession.
Earnings gains of pharmaceutical companies seem to roll on no matter what the economic outlook, as health-conscious Americans continue to buy medicine in large quantities. Many investment advisers who shifted clients into cyclical stocks earlier this year in anticipation of a quick end to the economic downturn would've been better off to simply stick with tried-and-true drug stocks.
Significant growth in the number of senior citizens, who consume more than twice the medication of younger Americans, is another long-term positive for the pharmaceutical industry.
"The excellent performance of the drug stocks over the past five years, including a 22 percent gain as a group this year, has been due to an 'absence of malice' when compared to other less predictable stock groups," explained Barbara Ryan, pharmaceuticals analyst with Prudential Securities.
"I don't believe the next several years will be quite as favorable, primarily because there will be more competition and their good image is already reflected in stock prices, but there is still potential.
"Investors are aware that drug companies are raising prices faster than the inflation rate," noted Larry Smith, pharmaceuticals analyst with Hambrecht & Quist Inc., who doesn't expect these stocks to perform quite as well if the overall economy improves soon.
Drug companies have an extremely long product cycle of many years and their products can be sold globally. The investment goal is to get in early on a company's product cycle and hang in long-term.
"I have some concern about the fact that more regulation of the drug industry is coming out of Washington than has been the case in a long time," said Andrew Offit, portfolio manager of Fidelity Select Health Care Portfolio, up 57 percent in value.
For example, there was passage earlier this year of the Medicaid bill for drug reimbursement, resulting in a 12.5 percent discounted Medicaid price this year and 15 percent next year, Offit said. That's the first government regulation of drug prices here ever.
There are obvious stars in the drug industry. Pfizer Inc. is top drug company stock pick of both Smith and Offit, thanks to the large number of drugs it has coming through the pipeline. Pfizer's Procardia XL once-a-day heart drug and its Difluccan antifungal drug were both introduced this year. In addition, approval is expected this year for its Zoloft depression drug, Zithromax fast-acting antibiotic and its Norvasc calcium channel blocker.
Merck & Co. is recommended by Ryan and Smith. That's based on its expected 20 percent earnings growth and some unique products, such as prostate-care drug Proscar, to be introduced in the United States late next year.
Bristol-Myers Squibb is another Ryan pick. She considers it a fine company, with 18 percent to 20 percent annual earnings growth, a strong research effort and good global markets.
Schering-Plough is favored by Offit and Ryan. A smaller company with $3.8 billion in annual sales, it has aggressive management and offers the likelihood of 20 percent earnings growth the next two years.