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?

    Learn more about the primary risks facing investors in the pharmaceutical and biotechnology industries. Find out how regulation ... Read Answer >>
  2. What is the drugs sector?

    Learn more about the drug industry and how new drugs are brought to market. Find out about how drug research is financed ... 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. Is the drugs sector better suited for active or passive investment?

    Learn how passive investing can make a person good money in the drugs sector, but shrewd active investing can make a person ... 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. What are the major barriers to entry for new companies in the drugs sector?

    Find out why barriers to entry for U.S. drug companies are so high and how the Food and Drug Administration, or FDA, inhibits ... Read Answer >>
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