The strength in the IPO market is an important indicator of liquidity, risk appetite and innovation in the drugs sector. Drug companies are under pressure to continually release new medicines to replace old ones that lose their patent protection. Many newer companies with promising drugs in development go public to raise capital so they can have funds to continually research, innovate and complete approval processes.

When young companies are easily able to go public and find demand for their shares despite their uncertain prospects, it is a good sign of liquidity and risk appetite in the sector. While drug companies spend heavily to develop new products, they can be unsuccessful in developing large enough products to replace old, blockbuster drugs. This is the major source of stress for drug companies.

With innovations in biotechnology, the cost of drug development has significantly decreased. With an increased understanding of the human genome, tests that once cost millions now cost thousands. Sophisticated computer equipment allows for virtualization of many processes that were once performed in the laboratory. Of course, at some stage, lab work is necessary but the trial and error part of it has been eliminated. This has also increased competition in drug development as barriers to entry have been reduced.

The strong IPO market makes it cheaper to raise capital and can spark cost inflation, as there is intense competition for talent. Established drug companies may find their most talented people being lured away by new companies offering equity or competitors offering more lucrative pay packages. This is one of the drawbacks of a strong IPO market, as costs can be expected to rise, eating away at profit margins. Talented employees may also leave to start their new endeavors when funding is easily available.

On the brighter side, these IPOs become another avenue for companies in the drugs sector to pick up promising treatments in development. Essentially, they are able to outsource the early stages of development in which the most risks and uncertainties are involved. However, a strong IPO market reflects liquidity and risk appetites in the sector. In one way, this is not good for drug companies as they have to pay higher multiples to purchase early stage companies due to this bullish sentiment and demand for assets. In this type of environment, it is not possible to find bargains.

One moderating factor is liquidity and risk appetites also end up driving multiples and valuation higher for entrenched players in the drugs sector. Therefore, the currency they use to make these transactions, their own stock, is also higher in value. Additionally, strong IPO markets are a reflection of consistent performance and promising innovation. Thus, drug companies' balance sheets are expected to be strong with healthy cash reserves when the IPO market is strong.

  1. What are the primary risks associated with investing in the drugs sector?

    Learn more about the primary risks facing investors in the pharmaceutical and biotechnology industries. Find out how regulation ... Read Answer >>
  2. What are the primary factors that drive share prices in the drugs sector?

    Learn about the primary factors that drive share prices in the drug sector. Creating and manufacturing drugs is a complex ... Read Answer >>
  3. How does government regulation impact the drugs sector?

    Learn about how drugs are regulated by the U.S. government as well as the role of the Food and Drug Administration during ... Read Answer >>
  4. What process does a company need to follow to bring a new drug to market?

    Learn about the costly price of bringing new drugs to market. Discover why the pharmaceutical industry invests billions of ... Read Answer >>
  5. What level of return on equity is average for a company in the drugs sector?

    Find out more about the drugs sector, which industries are included in the sector and the average return on equity for companies ... Read Answer >>
  6. How does the drug sector benefit from the growth of emerging markets?

    Understand how the pharmaceutical industry benefits from the growth of emerging markets. Benefits are linked to growing economies ... Read Answer >>
Related Articles
  1. Insights

    How Pharmaceutical Companies Price Their Drugs

    Learn more about how pharmaceutical companies price drugs, why prices are often very high and why it can be difficult to settle on a suitable price.
  2. Investing

    Using DCF In Biotech Valuation

    Valuing firms in this sector can seem like a black art, but there is a systematic way to pin a price on potential.
  3. Investing

    Where Does the US Get Its Supply of Drugs?

    Despite increasing demands for local production, the US imports only a small portion of its drugs.
  4. Insights

    8 Stages Of New Drug Development

    Understanding biotech data isn't easy. What is a clinical trial, what are the various phases, and why do the results of these trials and applications often create double-digit moves in the price ...
  5. Investing

    Orphan Drug Rules Are Being Manipulated

    It may be the time to revamp the Orphan Drug Program amid concerns it's turning into a scam.
  6. Retirement

    How to Pick the Best Medicare Part D Plan for You

    In choosing a Medicare Part D plan, here’s a helpful step-by-step guide to what you need to know to get the drugs you need at the price you can afford.
  7. Investing

    Senator Orders Investigation of Orphan Drug Abuse

    Iowa Senator Grassley ordered an inquiry into possible abuse of the Orphan Drug Act by drug makers.
  8. Investing

    The Risks And Rewards Of Pharma Stocks

    While pharmaceutical stocks have certain risks, big pharma companies have stable cash flows and pricing power, offering opportunities for profit.
  9. Investing

    Drug Price Debate May Lead to Smaller Price Hikes

    Some drug makers have capped drug price increases to single digits in 2017 amid public outcry.
  10. Investing

    Drug Supply Chain May Be Driver of High Drug Prices

    Non-manufacturing stakeholders in the drug pricing system are the ones contributing to high prices.
  1. New Drug

    A new medication or therapy that has not been used before in ...
  2. Drug

    A substance that cures, treats, prevents or reduces the symptoms ...
  3. Abbreviated New Drug Submission (ANDS)

    A written request to Health Canada to obtain marketing approval ...
  4. New Drug Application (NDA)

    The final step formally taken by a drug sponsor, wherein it applies ...
  5. Orphan Drug Credit

    A federal tax credit that provides an incentive for pharmaceutical ...
  6. Orange Book

    A list of drugs that the U.S. Food and Drug Administration has ...
Hot Definitions
  1. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  2. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  3. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  4. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  5. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  6. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
Trading Center