The drugs sector is a good choice for value investing because it always has demand and a competitive moat. This simplifies one task for the value investor. Value investors typically load up when valuations are low and business conditions are weak, with the dominant emotion being fear. Typically, they are most active during recessions.

One drawback to value investing is sometimes companies become cheap because the market is anticipating diminished earnings going forward due to structural changes in the economy. These are known as value traps and can be quite deadly for value investors' returns. The economy is constantly changing with new industries emerging and old ones dying; one pitfall of value investing is dying industries can at times look like compelling, cheap opportunities. Therefore, value investors need to go beyond identifying cheap stocks or sectors by also finding moats that ensure continued relevance.

Drugs Sector

The drugs sector, as a whole, certainly has a competitive moat. It is hard to imagine a future in which the economy changes in a way that erases the need for the drug industry. Of course, it is certainly possible that individual companies within the drugs sector are not able to develop new treatments and end up as poor investments. Drug companies temporarily have a competitive moat when they have patent protection on their products and are able to sell them exclusively, earning windfall profits.

Valuing drug companies is inherently difficult due to the uncertainty of determining future cash flows. An investment in a pharmaceuticals company is a vote of confidence that its management continues to successfully develop new drugs and bring them to market. Another option for management is to buy smaller companies with promising drugs in development. The massive cost of bringing a drug to market and the institutional knowledge required is a strong competitive moat for drug companies.

Favorable Trends

Many potent trends add to the appeal of the drugs sector for value investors. These are secular trends that hold true regardless of economic conditions. One is advances in biotechnology, which have significantly reduced the cost of drug development. This has morphed the development process from one of expensive trial and error to using genomics to cut costs by 90% in many instances. Futurists discuss a day when all types of treatment are personalized based on a patient's DNA.

Two more trends that should continue to drive revenue and earnings growth for the drugs sector are the Affordable Care Act and aging populations all over the world. Implementing the Affordable Care Act has insured nearly 17 million people. This created more customers for the drugs sector. Demographics is another factor leading to increased demand for drugs as the world's population ages. Older people consume more drugs, especially people in developed nations where there is more wealth and generous government subsidies.

  1. 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 >>
  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 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 >>
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  1. New Drug

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

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

    A written request to the U.S. Food and Drug Administration to ...
  4. Orange Book

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

    The competitive advantage that one company has over other companies ...
  6. Phase 2

    The second phase of clinical trials or studies for an experimental ...
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