Stock investors need a place to hide. U.S. pharmaceuticals are a good place to seek shelter.
Risky drug stocks have been a great place to invest for most of this decade. Those stocks, however, have lately fared even worse than the broader market. A broad index of small biotechnology stocks is down by 22% since the end of August. Larger biotech stocks with earnings and cash flow have fared better, but not by much.
The picture is different for the biggest U.S. pharmaceutical companies, however. The NYSE Arca Pharmaceutical Index (.DRG) is up about 7% so far this year, and about 11% since July. Big names have led the way. Merck & Co.(MRK) and Eli Lilly (LLY) are up 23% and 32%, respectively, while Pfizer (PFE) has gained 19%.
The bigger companies have lived up to their defensive reputations. Long-term growth prospects are modest, and third-quarter earnings were solid, albeit unspectacular. When investors are confident, they tend to overlook this sort of stock.
Add a little unrest to the markets, however, and the picture starts to change. After all, demand for medicine is far less sensitive to the economy than for most products, and balance sheets throughout the sector are strong. Cash payouts are high, and the biggest pharma companies have diverse product lines that insulate them against the risk of losing sales to new competition. In contrast, even bigger biotech stocks tend to have a few blockbuster products, which increases those eventual risks.
The industry’s pricing power does face long-term threats, but investors don’t need to worry about it just yet. Pfizer recently announced that it plans to raise prices on 41 of its drugs in January.
Most important, the stocks continue to trade at reasonable prices. Lilly commands 20 times forward earnings, with Merck and Pfizer at 16 and 14 times, respectively. All three trade at multiples not far from their five-year averages.
Investors feeling under the weather do have some medication at their disposal.
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