With some $1.6 trillion in global sales, the pharmaceutical industry is a steadily growing sector, thanks to the rise of personalized medicine, increases in chronic diseases, and an aging population worldwide. As such, investing in the pharmaceutical industry offers investors a range of potential opportunities.
But, as with any sector, pharmaceutical stocks come with specific risks — intense competition, lengthy drug approval processes, potential drug failures, and more. Investors would be wise to research each company before they buy stock.
Key Points
• The pharmaceutical industry, both in the U.S. and globally, is large and varied.
• The pharmaceutical market in the U.S. alone is predicted to grow at a CAGR of 5.72% between 2025 and 2030.
• Despite opportunities for investors, there are numerous risks in this sector, including intense competition and long approvals for drug treatments.
• Owing to the highly scientific and technical nature of pharmaceuticals, investors must do their due diligence when investing in any stock.
An Intro to the Pharmaceutical Industry
Pharmaceutical companies research, develop, make, and sell medications, including preventive medicines, treatments, and vaccines. Two segments of therapeutics make up the industry: pharmaceuticals and biologics.
It’s also important to know the difference between pharmaceutical stocks and biotech stocks, whether you’re investing online or through a traditional brokerage.
Pharmaceutical drugs are typically made from synthetic or plant-based chemicals.
Patents and Exclusivity
When drugs are first approved, they generally have a patent or market exclusivity, meaning that only the pharma company that developed them can manufacture and sell the drugs.
Once the patent or exclusivity ends, other companies can create generic forms of the drug and begin to compete with the pharma company. The generic drugs are chemical copies of the original drug but sell at lower prices, making it hard for the original pharma company to compete. This can lead to its stock losing value.
Understanding Biologics
Biologics are products such as vaccines, gene therapies, and medications for blood disorders, that are large, protein-based molecules made out of living cells. Biologics are more complex to manufacture, which is one reason they’re more expensive.
They also have tighter restrictions on distribution than pharmaceuticals do. These factors make it more challenging for companies to enter this space and for competitors to succeed. If competitors do create a similar product, it is called a biosimilar.
Unlike generics, biosimilars aren’t interchangeable, so biologics don’t have the same stock drop-off that pharmaceuticals do.
It takes about 10 years and an average of $1.3 billion to $2.8 billion to bring a new drug to market, but in special circumstances, the FDA can expedite approval.
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Why Invest in Pharmaceuticals?
With pharmaceuticals, whether investors are looking for high growth potential, long-term value, or stable dividends, they can find a pharma stock that will fit the bill.
Factors Impacting Industry Growth
The population of older adults is growing. About 10,000 Americans turn 65 every day, according to the AARP. And by 2030, the country will have more residents 65 and older than children, the Census Bureau has projected. This means more people are likely to need health care and pharmaceutical treatments, which in turn is expected to help pharma stocks grow.
U.S. health spending is projected to reach nearly $6.8 trillion by 2030, according to the Centers for Medicare & Medicaid Services.
Pharmaceutical stocks don’t always follow the same trends as other stocks because demand is inelastic: i.e., people need medication no matter what is going on in the market. This doesn’t mean that pharma stocks always perform better than the broader market, simply that this sector doesn’t move in sync with other stocks. Thus, investing in pharmaceutical stocks may provide some diversification.
This means that some pharmaceutical companies may see steady revenue, even when the rest of the stock market is down. Larger companies have fairly consistent income streams, while smaller companies that show promise get funding from investors and sometimes get acquired by larger companies.
A few other reasons pharmaceutical stocks look promising as a long-term investment:
• The health care sector is expanding in countries outside the United States.
• The government has been spending more on health care research.
• New types of therapies, such as gene therapy, are getting more sophisticated. Some of these are very expensive.
How to Choose Pharmaceutical Stocks
Billions of dollars are invested in medical research and drugs each year. But not every company becomes a success. As with any stocks, investors will want to research pharma stocks before buying. Here are a few key factors to look at when evaluating stocks.
Growth Prospects
By looking at a company’s earnings and revenue, one can see how much it’s been growing and whether growth is slowing down. Investors can also analyze each company’s pipeline to learn which drugs are close to being approved.
Pharma companies have to go through certain steps to develop, test, and get drugs approved. They often make pipelines available to the public, so investors can see which drugs are in the early stages of development, preclinical testing, going through clinical trials in humans, or getting FDA approval or other necessary regulatory approvals.
Drugs may get approval for treatment of certain diseases or for specific demographics, but the makers can then apply for approval for additional uses. If they get the expanded approval, this can lead to growth for the company.
Investors can follow different pharmaceutical companies to see when they have the potential to grow and become successful. If a pharma company has patents that are close to expiring, for instance, this may slow down growth, as competitors can create generic forms of the same drugs.
The process companies go through to develop and bring drugs to market is generally as follows:
• Drug discovery: During this phase, drugs and the diseases they can potentially treat are discovered and developed.
• Preclinical trials: Potential drugs get tested in test tubes or on live animals at this early phase.
• Clinical trials: Small human trials help determine a safe dosage and how humans react to it. Then, groups of 100 or more people test the drug to discover short-term side effects and optimal dosage. Finally, groups of hundreds or thousands of people test the drug to determine efficacy and safety.
When drugs reach the clinical trial stage, this could be a good time for investors to keep an eye on them. If a drug makes it through trials, the company has potential for significant growth. But if the drug fails during testing, the stock is unlikely to do well.
• Regulatory approval: In the United States, the Food and Drug Administration’s Center for Drug Evaluation and Research assesses and approves new drugs. In the E.U., approval is completed by the European Medicines Agency.
Types of FDA Application
There are different types of pharmaceutical FDA applications, some of which give companies more potential for stock growth than others. The application types are:
• Investigational new drug application: This is the first application step that companies must go through.
• New drug application: This is an application to market and sell a new drug. Companies filing this application have the most potential for stock growth because they are introducing a new product to market.
• Abbreviated new drug application: Companies developing a generic form of an existing drug go through this application.
• Therapeutic biologics application: This is required under the PHS Act for biologics.
• Over-the-counter drug application: This is for companies looking to sell over-the-counter drugs, which are categorized as being safe to distribute without a prescription.
Dividends
Not all pharmaceutical companies pay dividends, but some of them do provide consistent payouts to investors. Dividends provide a stream of income, or can be reinvested.
Qualitative and Quantitative Metrics
The same rules apply to pharmaceutical stocks as to any other stock when it comes to evaluation. Investors should look at a company’s valuation, revenues, growth, leadership team, product pipeline, and other key metrics to decide whether to invest. Stock valuation ratios, such as price-to-earnings ratio and price-to-earnings-growth ratio, are very useful when comparing different stocks within the same industry.
However, some pharmaceutical companies are not yet profitable if they are in the drug development and trial phases. In this case, investors can look at the rate of cash burn: how much money the company is spending each quarter to develop a drug. It’s very expensive to develop a drug, so if a company is burning through cash and doesn’t have much left to work with, this might not bode well for the stock.
Another useful metric to look at is the price-to-sales ratio. This compares a company’s sales to the price of its stock. If the company doesn’t have sales yet, investors can make predictions about what those sales figures might look like.
Trends and Developments
Over time, trends in the types of diseases being targeted and the types of therapies being developed change. Investors can look into stocks in popular areas of treatment to find stocks with growth potential.
For instance, many drugs are in development to treat breast cancer and non-small-cell lung cancer. Treatments that are bringing in significant revenue globally include oncologics, antidiabetics, respiratory therapies, and autoimmune disease drugs.
Additional lucrative treatment areas include antibiotics, anticoagulants, pain, and mental health drugs.
Risks of Investing in Pharmaceutical Stocks
As with any type of investment, pharma stocks come with some risks. Some of the main risks to be aware of are:
• Clinical failure: Many drugs don’t make it through the phases of clinical trials. If a drug has made it to the final stage, it’s more likely to succeed, but even at this phase, drugs can fail.
• Inability to obtain approval: Just because a drug does well in trials doesn’t mean it will be approved by regulatory agencies.
• Difficulties getting reimbursement and pricing drugs: Health insurance companies, government programs, or individuals must cover the cost of drugs, and companies aren’t always able to secure the money they need. Sometimes, companies are pressured to lower the price of drugs to make them more accessible, and this can result in financial struggles for the company.
• Industry competition: As mentioned, when patents run out, pharma companies may struggle to keep up with competitors that develop cheaper generic versions of drugs. In addition, during the drug development phase, it’s not uncommon for multiple companies to be working on medications to treat the same illness. If one company can make it to trials or get approval first, this can put them way ahead of the competition, especially if it results in patent exclusivity.
• Litigation and liability: In the pharmaceutical industry, lawsuits are common. Drugs can also be recalled from the market if they’re found to be unsafe.
The Takeaway
If you’re looking to start investing in the pharmaceutical industry, you might consider buying pharmaceutical ETFs. Or, you could do your due diligence and choose individual stocks, aiming for stable dividends or growth potential. Before investing, it helps to familiarize yourself with the pharmaceutical industry to better understand how to choose pharma investments, and also ensure you understand the potential risks of investing in pharmaceutical stocks.
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