The primary factors that drive share prices in the drugs sector are mergers and acquisitions activity, spending on health care and earnings growth. The drugs sector develops and produces pharmaceutical products. It spans massive corporations worth hundreds of billions of dollars with hundreds of products to small startup companies with a couple of compounds in development.

In recent years, the drugs sector has been one of the biggest gainers due to 1) advances in biotechnology that have reduced the cost of drug development, and 2) the Affordable Care Act, which has increased demand for health care by insuring nearly every American.

Mergers and Acquisitions Activity

Given the huge cost and uncertainties of developing drugs, as well as the extensive regulatory hurdles that must be crossed, it makes sense that mergers and acquisitions is a large driver of share prices in the sector. Large corporations routinely buy out early-stage companies that lack the resources to bring a drug to market. This is a symbiotic relationship, as large corporations can outsource research and development costs, while the smaller companies are bought out at a premium. The principals are able to make money even if the drug never reaches market.

Larger corporations looking to bulk up their revenue centers may target competitors as well. This type of activity proliferates during periods of low interest rates, when larger players can use their massive balance sheets and steady cash flows to borrow money at low rates.

Spending on Health Care

The world's population is aging, and old people make up the vast majority of revenues for the drugs sector. Most developed nations subsidize the cost of medical care for their older citizens, so drug companies are incentivized to create products for this group.

Passing the Affordable Care Act insured around 25 million people who were previously uninsured, leading to increased spending on health care, which has been a bullish catalyst for the group. Aggregate spending on health care is the major driver of the sector's share prices over the long term. Since the world continues to grow older, demand continues to grow for drugs on a worldwide basis.

Earnings Growth

Of course, these trends are bullish for the stocks because they eventually manifest in increased earnings for the stocks in the sector. Future earnings streams for individual drug companies are determined by the drugs under development. Investors pay close attention to these factors to predict earnings in coming years, and stock prices move based on these shifting assessments.

Over the long run, stock prices are determined by how much they earn in profits. In the drugs sector, this means that companies continue to be successful in bringing profitable treatments to market in a cost-effective manner. Stock prices can see big increases if earnings beat investor expectations with positive forward guidance. They can also see big losses if earnings are below expectations.

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

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  2. How does government regulation impact the drugs sector?

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  3. Is the drugs sector better suited for active or passive investment?

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  4. What process does a company need to follow to bring a new drug to market?

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  5. What debt/equity ratio is common for companies in the drugs sector?

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  6. Can your insurance company drug test you?

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  1. New Drug

    A new medication or therapy that has not been used before in ...
  2. Abbreviated New Drug Submission (ANDS)

    A written request to Health Canada to obtain marketing approval ...
  3. Orphan Drug Credit

    A federal tax credit that provides an incentive for pharmaceutical ...
  4. Abbreviated New Drug Application (ANDA)

    A written request to the U.S. Food and Drug Administration to ...
  5. Healthcare Sector

    The healthcare sector consists of companies that provide medical ...
  6. Orange Book

    A list of drugs that the U.S. Food and Drug Administration has ...
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