The drug stocks have been able to continue their uptrend during the first half of 2011 and are easily beating the overall market. The PHLX Drug Sector Index is up 8% year-to-date as the S&P 500 is only up 3.8%.
For years, the major drug makers have been viewed as "has-beens" due to their lack of new drug discoveries and less-than-promising futures. But recently, three strong factors are driving investors to the sector. The combination of attractive values, above-average dividend yields and the perception of a "safety" sector all rolled together have attracted money.
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My top picks in the sector (in no specific order) begin with Novartis (NYSE:NVS), the Swiss pharmaceutical firm. The company offers products that include innovative drugs, eye care products, generic drugs, consumer health products, vaccines and animal health products. Its top two selling drugs are Diovan and Gleevec, a hypertension and cancer drug, respectively. Fundamentally the stock trades with a forward P/E ratio of 10.5 and pays a dividend of 3.3%. After hitting a fresh all-time high earlier this month, the stock has pulled back to support and is now a very attractive opportunity.
Pfizer (NYSE:PFE) is another global pharmaceutical company based in the U.S. that offers products across 11 therapeutic areas. Some of the company's well-known drugs include Viagra, Celebrex and Chantix. The stock trades with a forward P/E ratio of 9.0 and pays a 4.0% dividend. Technically the stock is well off its all-time high. But it is consolidating near a yearly high, and a breakout above $22 would be a bullish signal.
Allergan (NYSE:AGN) is not as diverse as the first two companies and is divided into two divisions - specialty pharmaceuticals and medical devices. I always think of the company as the "stay young" drug company. Two of its biggest products are Botox and breast implants. With the baby boomers sitting on cash and getting older, it only makes sense they will run to AGN for their products. Fundamentally, the company trades with a forward P/E ratio of 19.8 and pays a small dividend of 0.2%. The stock is currently sitting less than 1 percent from a new all-time high, and it appears it is poised to break the record in the very near future.
Investors that do not want to concentrate on an individual stock have the option of an ETF. One of my favorites is the PowerShares Pharmaceuticals ETF (NYSE:PJP). The ETF consists of 30 stocks and charges an annual expense ratio of 0.63%. The top holding, Abbott Labs (NYSE:ABT), makes up 5% of the portfolio, and both AGN and PFE are listed in the top 20 holdings. The distribution yield is a low 0.9%.
The Bottom Line
To me, there are two major risks in investing in the major pharmaceutical stocks. First, if the market rallies, the big money could rotate out of healthcare stocks and into higher beta stocks. The second risk is that approval of new drugs becomes tougher, thus lowering the sector's growth. That being said, all sectors have specific risks that investors must weigh. (For related reading, see Pharmaceutical Sector: Does The FDA Help Or Harm?)
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