Research and development (R&D) plays an integral role in the success of pharmaceutical firms. According to a study conducted by Booz & Co, the healthcare industry had R&D expenditures of over $111 billion in 2009. Based on evidence provided in the report, of the 10 most research-intensive firms in the world, six are in the healthcare industry.

IN PICTURES: 5 Tips To Reading The Balance Sheet

The Tech Factor
Not surprisingly, tech-based firms such as Nokia (NYSE:NOK) and IBM (NYSE:IBM) cumulatively devoted the most resources to research and development, while the auto industry, which is pushing to rebrand its image to one of a more environmentally friendly business, came in third. Computing/electronics and autos had 2009 R&D expenditures of $146.7 and $85.2 billion respectively.

R&D in Healthcare
After analyzing R&D spending of the world's 1,000 top innovation-driven companies, Booz & Co. revealed that 2009 spending decreased by an average 3.5%. Although most of the declines were attributed to the auto industry, many American healthcare firms saw cutbacks as well.

Pfizer (NYSE:PFE) and Johnson & Johnson (NYSE:JNJ), which ranked in the five and seven spots on the list, saw year-over-year outlays decrease by 2.6% and 7.8% respectively.

Expiring Patents
However, with improving economic conditions, major pharmaceuticals are forced to renew their focus on R&D spending. As numerous major drugs such as Pfizer's Lipitor and GlaxoSmithKline's (NYSE:GSK) Advair lose their patents, generic drug makers will enter the market and begin to mass produce these medications. The best-selling cholesterol drug, Lipitor, contributed $8.1 billion to Pfizer's top line as of the first nine months of 2010. In fact, Lipitor sales contribute approximate 16.1% to Pfizer's total year to date revenue. Xalatan, another drug with an expiring patent in 2011 produced third-quarter sales of $416 million.

Israel's generic pharmaceutical giant, Teva (Nasdaq:TEVA), is set to capitalize on the growing list of patents set to expire in upcoming years. A major advantage for generic drug manufacturers is that they can allocate fewer resources to R&D. For example, Teva's nine-month R&D-to-sales ratio sits at 5.7%, compared to Pfizer's 13.1%.

In its latest quarter, Teva's North American sales increased by 22%, largely driven by a generic version of Pfizer's antidepressant, Effexor.

The major drug companies have two primary alternatives to maintain revenue growth: boost R&D spending and/or acquire competitors with drugs in the pipeline, which can replace the sales lost to generic brands. The major drug companies have been utilizing both approaches.

Merck (NYSE:MRK) increased its third-quarter research and development expense by 77%, spending $2.3 billion compared to $1.3 billion in 2009. Likewise, Pfizer's R&D spending surged from $1.63 billion to $2.19 billion. Furthermore, both of these corporations have been involved in large acquisitions with Merck purchasing Millipore for $7 billion. Pfizer is acquiring Wyeth for $68 billion.

The Bottom Line
Research and development spending is a crucial component of the pharmaceutical industry, as drug companies cannot rely on previously-developed technology to drive profits indefinitely. With many major patents expiring in 2011, companies will be forced to find alternative revenue streams. (Investors take note: companies that cut research and development are in danger of saving today but losing big tomorrow. Check out Buying Into Corporate Research & Development.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center