The term “big pharma” refers to the global pharmaceutical industry, which includes giant corporations that bring in billions of dollars in annual profit. The modern pharmaceutical industry has roots tracing back to the 19th century when research in areas such as chemistry and physiology allowed for the discovery of new drugs with medicinal qualities.
As the pharmaceutical industry developed and grew, a need for strong regulation emerged. Federal drug regulation began as early as 1848, but the U.S. Food and Drug Administration (FDA) did not get its name until 1930. It wasn’t until 1938 when a law was enacted that required new drugs to be subjected to a safety evaluation before they could be sold to the public. This requirement exists to this day in the form of clinical trials.
Today, the global pharmaceutical market is very big business, with annual revenues expected to top $1.5 trillion in 2023, according to the International Federation of Pharmaceutical Manufacturers & Associations. Many of the leading companies are involved in hundreds of clinical trials at a time and always looking for the next great drug breakthrough.
Fast facts about the world’s largest pharmaceutical companies:
- Almost half (48.6 percent) of Americans used at least one prescription drug in the past 30 days, according to data from the Centers for Disease Control and Prevention, which measured this from 2015-2018.
- 24 percent of Americans used at least 3 prescription drugs in the past 30 days, according to the same CDC data.
- Global pharmaceutical research and development spending is expected to top $200 billion in 2022, according to IFPMA.
- Total U.S. advertising spending by pharmaceutical companies was about $6.6 billion in 2020, according to media research firm Kantar.
- From 2009-2018, the average net price of brand-name prescription drugs increased from $149 to $353 in Medicare Part D and from $147 to $218 in Medicaid, according to a study by the Congressional Budget Office.
- Generic drugs, which are cheaper than brand-name drugs, accounted for 90 percent of U.S. prescriptions in 2018, up from 75 percent in 2009, according to the CBO report.
Big pharma stocks and return on investment
The pharmaceutical industry has been a solid place to invest money over time. The largest companies are profitable and typically share a portion of their cash flow with shareholders in the form of dividends and share repurchases. These dividend payments make the pharmaceutical industry an option for those looking for passive income ideas.
Investing in individual companies always comes with additional risk and the pharmaceutical industry is no exception. With the drug pipelines of pharmaceutical companies constantly changing and clinical drug trials succeeding and failing, you take on significant risk by holding the stock of just one drug company.
But the industry as a whole has provided stable returns over time. The iShares U.S. Pharmaceutical ETF (IHE), which tracks the performance of the U.S. drug industry, has returned nearly 11 percent annually over the past decade and has generated positive returns in 8 out of 10 years.
Pharmaceutical R&D spending
Pharmaceutical companies spend massive amounts of money on research and development (R&D) in order to discover new drugs that will propel them into the future. Global R&D spending by pharmaceutical companies reached $200 billion in 2020, according to Statista. Johnson & Johnson (JNJ) alone spent $14.7 billion on R&D in 2021, while Pfizer (PFE) spent $13.8 billion.
When a company discovers a new drug, it’s given the exclusive marketing rights for a period of time as a reward for its R&D efforts. Once the drug comes off patent, generic drug manufacturers are able to produce and sell the drug at a significant discount, which impacts the business of the company that discovered the drug initially.
High profit margins
When analyzing companies for a potential investment, profit margin is one of the most important financial ratios to look at, and the pharmaceutical industry is impressive in this area. Profit margins measure how much a company makes in profit for each dollar of revenue it takes in.
Johnson & Johnson, Pfizer and AbbVie (ABBV) all earned operating profit margins well above 20 percent over each of the past 5 years. Pharmaceutical companies earned about 25 cents in operating profit for every dollar of revenue they took in compared to about 12 cents for the overall market, according to January 2022 data from New York University.
The high profit margins enjoyed by drug companies are partially due to the legal monopoly they receive on new drugs they develop, allowing them to price the product well above their costs.
Record-breaking mega mergers
Recent years have seen pharmaceutical giants go on a shopping spree, allowing some of the biggest players to get even bigger. In 2019 alone, Bristol Myers Squibb (BMY) agreed to buy Celgene for about $74 billion, while AbbVie bought Allergan for about $63 billion. AstraZeneca (AZN) announced its $39 billion deal for Alexion Pharmaceuticals in 2020.
These types of deals can allow companies to expand into new areas and protect themselves when key drugs are set to go off patent protection, creating new competition. Because the companies are so profitable, they often have strong balance sheets that can support large acquisitions.
Big pharma, big pipelines
Pharmaceutical companies are constantly searching for new drugs that can treat diseases or improve on the existing treatments. R&D spending supports this search at every step of the process, all the way from the initial research through the clinical trials.
Whether a drug will be successful and approved for use is unpredictable and the process takes years to complete. Because of this, certain drug companies have hundreds of drugs in their pipelines at different stages of the approval process. Novartis and Roche each had about 150 drugs in their pipelines as of 2022, according to investor presentations.
Investing in big pharma
Investing in the pharmaceutical industry has largely been and should continue to be profitable for investors. The industry enjoys high profit margins and generates significant cash flow for investors. If you’re buying individual stocks, make sure you understand the drugs that contribute most to the company’s earnings and when those drugs are set to go off patent protection. You’ll also want to get a sense for the relative strength of the pipeline.
Buying an ETF or mutual fund that tracks the pharmaceutical industry can be a great way to invest in drug companies without having to get in the weeds on individual products and companies. These funds hold companies throughout the industry, allowing you to profit off their strong economics. Here are a few popular options.
iShares US Pharmaceuticals ETF
The iShares U.S. Pharmaceuticals ETF seeks to replicate the investment performance of an index that tracks U.S. pharmaceutical stocks. You’ll get exposure to companies that manufacture prescription and over-the-counter drugs or vaccines.
10-year annualized return: 10.7 percent
Dividend yield: 1.6 percent
Expense ratio: 0.42 percent
VanEck Pharmaceutical ETF
The VanEck Pharmaceutical ETF (PPH) seeks to track the performance of the MVIS U.S. Listed Pharmaceutical 25 Index, which is used to track the overall performance of the pharmaceutical industry.
10-year annualized return: 10.3 percent
Dividend yield: 1.6 percent
Expense ratio: 0.35 percent
SPDR S&P Pharmaceuticals ETF
The SPDR S&P Pharmaceuticals ETF (XPH) seeks to track the investment performance of the S&P Pharmaceuticals Select Industry Index. The fund aims to provide diversified exposure to the pharmaceutical industry.
10-year annualized return: 6.4 percent
Dividend yield: 1.3 percent
Expense ratio: 0.35 percent
Note: Return data as of May 31, 2022
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