Pharmacy benefit managers or PBMs control an important part of the healthcare system. These companies work with insurance companies to manage the pharmaceutical component of the healthcare benefits. There are three large competitors in the space: Medco Health Solutions (NYSE:MHS), Express Scripts (NYSE:ESRX) and Caremark. Other companies, like SXC Health Solutions (Nasdaq:SXCI) offer PBM services but also a full suite of healthcare-technology solutions geared toward the pharmacological side of healthcare. There are also some smaller or niche PBMs that focus on a particular area of the business. The economics of the PBM business improve when they have a larger percent of scripts delivered by mail and written for generic versions rather than branded versions of the drugs.


IN PICTURES: 4 More Can't-Miss Health Deductions

The push to get customers to order drugs via mail is beneficial to both the PBM (and thus the insurance company) and the customer, as the cost of a three-month supply is typically equal to or cheaper than the cost of a two-month supply from the traditional store front drug store. Similarly, the use of the generic version of a medication saves both the PBM and the customer on the overall cost. So when customers order the generic version of drugs via mail, the profitability for PBMs and the savings for customers is greatest. Another area of high profits for PBMs is with specialty drugs - generally considered injectable drugs. This area has very high profit margins for the companies but also requires more specialization.

Blockbuster Generics Are Coming
The top-selling drug at approximately $12 billion worldwide is the cholesterol-lowering drug Lipitor, manufactured by Pfizer (NYSE:PFE). Lipitor is scheduled to lose patent protection this year. Sales of a generic version of Lipitor should add significant profit to the PBMs bottom lines. Other popular drugs are also losing patent protection between now and 2014. These include Plavix, with about $10 billion in worldwide sales and Zyprexa, with over $2 billion in worldwide sales, among others.

The Stocks
Medco is trading near its 52-week high of $65 and at a ttm P/E of 20-times, this stock looks ripe. However, its expected 20% growth rate may not be appreciating the full effect of the blockbuster generics coming to the market. Similarly, Express Scripts, trading near its 52-week high of $58, has a ttm P/E of over 29-times. ESRX, with the positive impact from the integration of Wellpoint's (NYSE:WLP) PBM, has a higher expected growth rate of close to 29%. SXC paints the same picture - at its 52-week high and with a ttm P/E that far exceeds its bigger peers, or 48-times, although this company trades somewhat like a technology company.

Conclusion
While these stocks look like they've discounted the potential impact from the upcoming generic launches of many blockbuster drugs, the true impact may be far greater, particularly if the PBMs can switch customers to mail and to the generic versions at a faster rate. The actual growth rates can far exceed the expected and these stocks will look cheap and far from fully valued. (Take a page from the tortoise and the hare fable by investing in these constant growth stocks. See Steady Growth Stocks Win The Race.)

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

Related Articles
  1. Insurance

    What Does It Cost To Raise a Child in America?

    Having a family can be an expensive proposition, but couples who know the numbers can strategize to lower the costs.
  2. Investing

    Build a Retirement Portfolio for a Different World

    When it comes to retirement rules of thumb, the financial industry is experiencing new guidelines and the new rules for navigating retirement.
  3. Insurance

    Explaining Co-Pays

    A co-pay is a set dollar amount an insured patient pays when visiting a doctor, filling a prescription, having tests performed or receiving other medical treatment.
  4. Investing Basics

    Understanding Brokerage Fees

    Agents charge brokerage fees for facilitating transactions between buyers and sellers.
  5. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  6. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  7. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  9. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Net Collections

    A term used in medical accounting to describe the amount of money ...
  3. Corridor Deductible

    Expenses that are paid by the insured in excess of an insurance ...
  4. Insurance Consortium

    A group of businesses or organizations that join together to ...
  5. Blanket Medical Expense

    An insurance policy which provides coverage for all medical expenses ...
  6. Classified Insurance

    Insurance coverage provided to a policyholder that is considered ...
RELATED FAQS
  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

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!